01 Nov Lessons From The Toys R Us Bankruptcy
Lessons From The Toys R Us Bankruptcy
The story of the Toys R Us bankruptcy has progressed quickly this week.
Only announced a few days ago, we now know of the retailer’s debtor-in-possession (DIP) financing and understand that, for the most part, existing senior debtholders will be participating in the raising of $3+ billion in new money.
In the aftermath of the bankruptcy news, we could see from an analysis of the credit documentation and bankruptcy filings that the complex inter-creditor agreements and intercompany loans meant it wasn’t immediately clear who would get what. This is why select existing debtholders are taking part in the refinancing, as it will help to protect their senior most creditor position.
I’ve read some commentators suggest that the company should have been liquidated rather than filing for bankruptcy. It’s unclear which will turn out to be the correct choice but the DIP lenders, who would have been privy to confidential information, must believe that the company has a good shot at a sound future to have made this decision.
There has been a lot written about the company’s underlying business model too. This has centered on two key factors affecting the business negatively – its large, dated physical store network and the rise of internet rivals, primarily Amazon.
In-store vs online
In terms of physical stores, it’s clear that Toys R Us’ business flourished as general stores made way for strip malls and outdoor shopping centers that could be reached by car. Of course, all stores can be costly to run and it seems that Toys R Us has failed to maintain a quality shopping experience, where consumers are drawn in by being able to try products before they buy.
The other dynamic at play is, of the course, the internet. Consumer behavior has changed from people wandering up and down aisles to people browsing online stores. Amazon’s transformational online experience has affected many retail sectors and, while it can be argued that Toys R Us has not moved with the times to develop its digital presence, there’s no doubt that the online giants have affected its business.
Don’t forget the debt
For all of the macro issues that might be at play though, I can’t help but focus on the more immediate issue of the debt load. To understand this more fully, it’s worth looking back at the events that led up to the bankruptcy filing.
The recent issues began when it was leaked that the company was negotiating a refinancing with its B4 term loan holders. This news made suppliers skittish about providing inventory on credit and occurred at a crucial time for the company as it was ramping up inventory in advance of the holiday season.
Some of these suppliers were already owed tens of millions of dollars, so the fear that started with the leak meant that they pulled their credit lines. As a result, Toys R Us was left needing to find nearly $1 billion in additional liquidity to purchase inventory, an impossible task under the circumstances. This forced the company into a rushed bankruptcy filing, and the DIP financing is allowing them to keep operating through the aforementioned holiday season.
This story is about excessive debt and the fine line than some companies operate under, particularly in retail. Toys R Us isn’t alone in having these sorts of complex capital structures and this incident is a warning of what risks exist.
Even though a leak sparked fear that couldn’t be contained, the devil really lies in the details of the situation. Corporate structure maps that highlight subsidiary ownership, debt outstanding at each entity and guarantor obligations can help uncover risks and provide a framework for investors and analysts to understand how things might play out.
About The Author
Stephen Hazelton, founder and CEO of Street Diligence, a leading provider of fixed income analytics on bonds and bank loans.