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Charlie Raith

Professor McLaughlin

Writing and Rhetoric

12.11.18

All Grown Up: The Downfall of Toys “R” Us

Upon hearing of Toys “R” Us’ closing, we are naturally inclined to recall childhood

memories of pacing the superstore’s endless aisles in search of the newest toys. But to the

chain’s roughly 31,000 employees, the closure signifies a much more realistic situation. Former

employees lost their jobs and were denied a severance package is commonly promised when

large businesses go under. According to CNN’s Chris Isidore, employees were “promised 60

days pay, which is required by federal law”, but the only type of severance packages they will

receive are standard health insurance payments and matching contributions to 401(k)

plans” (Isidore). Toys “R” Us employees were victims of an event that was completely out of

their control; however, these employees will not be alone, as retail stores are expecting “more

than 3,800 closures” in 2018 alone, led by Toys “R” Us, Gap and Walgreens (Peterson). This

paper will examine the underlying factors that contributed to the closure of Toys “R” Us. First, I

will acknowledge the various theories that attempt to explain the toy retailers closure. Then, I

will discuss the lessons that retail corporations need to discern from its failure, such as the

dangers of excessive debt and fees, and unprepared and uninvolved management. I will

conclude by providing an alternative view of the practices of private equity and establish the role

that Toys “R” Us will continue to serve even after its closure.

Many attribute the collapse of Toys “R” Us, and other failed retailers, to a heightening of

industry competition, brought on by powerhouse retailers, such as Walmart and Target, and e-

commerce giant Amazon. The New York Times’ Michael Corkery mentions, “in the age of

internet retailing, Toys “R” Us has struggled with an antiquated sales model that could not keep
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up with Amazon and Walmart” (Corkery). With big box retailers driving prices down and Amazon

capturing much of the retail customer base, it is believed that Toys “R” Us simply couldn’t

compete. In a Digital Commerce 360 article by James Melton, Ben Row, a retail specialist at

online sales software provider Bigtincan, argues that “Toys R Us was entering into a losing

battle—they were never going to win a price war against Amazon and the big-box stores like

Walmart and Target” (Melton). Competing to provide low prices with the efficiency-savvy and

mass production forces Wal-Mart, Target and Amazon would be a tall task for any corporation,

and according to some, it was why Toys “R” Us couldn’t sustain it’s business.

Perhaps a seemingly obvious reason for the demise of Toys “R” Us’ was the changing

landscape of the toy market itself. In Bloomberg Businessweek columnist Tara Lachapelle’s

article, “Lessons Learned From the Downfall of Toys 'R' Us, she asserts that Toys “R” Us “was

hurt by… shifting trends that saw more kids choosing to play with iPads over Barbie dolls and

Hot Wheels” (Lachapelle). Centered around kids’ desire to play with real toys rather than apps

or video games, Toys “R” Us’ downfall could potentially be pinned on a shift in the landscape

towards the latter of the two toy options. However, this claim can easily be refuted by looking at

the total revenue from retail sales of toys in the U.S. from 2013-2017, which grew from $17.68

billion to $20.74 billion (Statista). Increasing total revenue, combined with “the 13.6% market

share held by Toys R Us”, makes it clear that there were forces other than changes in kids’

appetite for toys involved in Toys “R” Us’ failure (Statista).

Despite the potential role that a rapidly changing, competitive market played in Toys “R”

Us’ collapse, the most significant contributor was its private equity buyout in 2005. The publicity

surrounding its collapse, and the involvement of three prominent private equity firms, has

increased public awareness of a commonly overlooked and misunderstood problem. Private

equity firms frequently utilize a financial transaction known as a leveraged buyout, in which the

purchasing P.E. firm buys all the public shares to acquire an entire company from it’s current
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shareholders. The purchasing private equity firm, in an attempt to increase company profits and

then resell the business, becomes an active manager in the company they acquire. As a

solution that could potentially help struggling companies turn their businesses around, U.S.

retailers often agree to this type of buyout. However, as highlighted through Toys “R” Us’ recent

history, this process comes with significant risk and can often lead to serious financial struggle.

In a 2017 article for Newsday, Aisha Al-Muslim “found that 43 large retail or supermarket

companies… have filed for bankruptcy in the United States since January 2015” and, of those

43, “18 — more than 40 percent — were owned by private equity firms” (Al-Muslim). An

acknowledgement of recent retail struggles is’t complete unless it considers the influence of

outside private equity purchase. It’s clear that these financial transactions, and the firms that

execute them, are contributing to the larger trend of the deterioration of retail corporations.

In the case of Toys “R” Us, its management agreed to the company’s purchase by

outside Private Equity firms KKR, Bain Capital and the real estate investment trust Vornado in

2005 (Lachapelle). The buyers raised money from investors and borrowed money from banks to

purchase all the outstanding shares of Toys “R” Us, transforming the company from one that’s

public to one that’s privately owned. This change eliminated any obligation to share profits with

public shareholders and would allow Toys “R” Us management the opportunity to reinvest profits

in the business. The borrowed money, known as leverage, then became debt on the company’s

books and required consistent annual interest payments. However, because the buyers also

became actively involved in the company’s business decisions, they were paid management

fees by Toys “R” Us. Similar to most leveraged buyouts, KKR, Bain Capital and Vornado

intended on a leveraged purchase, a revamping and renewal of the company, and then an exit

for themselves after realizing sizable returns on their initial investment. However, as Toys “R”

Us’ struggles hindered its profitability, the three purchasers remained active owners and

managers of Toys “R” Us until it’s bankruptcy and closure.

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The specifics of Toys “R” Us’ buyout deal provides retailers with evidence as to why they

should be wary when considering outside buyouts. Toys “R” Us had the potential to thrive, with

“toy industry sales… growing at a 5% annual compound rate since 2013”, but instead slowly

disintegrated into eventual closure (Isidore). The excessive increase in debt, the implementation

of a new ownership group incapable of adapting, and the wide range of fees that accompanied

Toys “R” Us’ buyout highlight the major risks of private equity purchases that all retailers need to

recognize and learn from. Private equity is playing a role in the struggles of retail sector, and the

case of Toys “R” Us can provide vital information into how and why outside buyouts so

frequently result in disaster.

The overuse of debt, or leverage, left Toys “R” Us cash strapped due to its steep interest

obligations, setting the toy seller up for failure. According to Tara Lachapelle, by 2007 “the

retailer's interest expense spiked to 97 percent of its operating profit”, which means that 97% of

Toys “R” Us’ total pre-tax profit was owed to the banks that lent money for the 2005 buyout

(Lachapelle). This is a clear indicator of a company in an unhealthy financial state. Although

most companies are debt-laden, none are so suffocated by the interest on that debt that

available cash is seriously threatened. Prior to it’s buyout, Toys “R” Us’ debt levels hovered

between $500 million and $1.5 billion. After the buyout, it jumped to $5 billion and never

dropped below $4 billion in the ensuing years (Lachapelle). Toys “R” Us was forced to pay more

than $400 million a year in interest alone on its debts”(Lachapelle). Struggling to pay those

interest payments, Toys “R” Us’ main focus became survival, not growth and innovation.

Although the use of debt can provide building blocks for companies to expand, Toys “R” Us’ debt

levels did the opposite. U.S. retailers need to be cautious when acquiring debt, as it has the

potential to diminish profit margins and put the companies’ financial stability in jeopardy.

Toys “R” Us’ overburdened balance sheet definitely limited its ability to innovate;

however, its new ownership group failed to make any significant changes to manage the debt
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and progress the company forward. The excessive debt levels taken on by the retailer could’ve

only been justified had its purchasers implemented changes that increased revenues or

decreased costs. Unfortunately, few changes were made, leaving the company to eventually

drown in its own debt. Typically, when private equity firms purchase companies, they “provide

access to management expertise and financial resources”, to improve the company’s financial

health (Appelbaum). However, Michael Corkery of the The New York Times points out that, “the

company’s lenders grew worried about whether Toys “R” Us executives were taking steps

drastic enough to restructure the business to allow it to compete over the long term” (Corkery).

Restructuring was needed, and the banks that funded the buyout knew it, but sufficient action

wasn’t taken. In his article, “What Went Wrong: The Demise of Toys R Us”, Columbia

University’s Mark Cohen argues, “the stores were too big, jammed full of inventory, poorly

merchandised, and customer service was virtually nonexistent” (Dalhoff and Cohen). These

types of issues must be handled by upper management, yet Toys “R” Us’ ownership failed to

step in. Cohen later adds, “Toys R Us has failed to innovate its business model, incorporate

technology or adapt to changing consumer behavior” (Dalhoff and Cohen). Retailers seeking

private equity buyouts need to be aware of the type of leadership and strategy that

accompanies new ownership. Toys “R” Us’ purchasers provided little to no guidance for

improvement and implemented little change to counteract its debt levels, seriously crippling the

company. Retail executives must exhibit sufficient due diligence regarding their purchasing firm

prior to agreeing to a buyout, or else they risk a fate similar to that of Toys “R” Us.

The lack of managerial action that the private equity owners of Toys “R” Us exhibited can

also be attributed to the various fees they were paid. Not only did these fees come straight out

of Toys “R” Us’ revenue, but the bystander approach that KKR, Bain Capital and Vornado

appeared to take in the handling of Toys “R” Us was a result of the fees limiting their losses.

Anna Nicolaou points out in her Financial Times article that the “buyout firms have paid
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themselves over $200m in expenses, advisory and management fees, according to SEC filings

over 12 years of ownership” (Nicolaou). Although private equity owners can see sizable returns

on their investments if the purchased company prospers, fees allow them to still profit if the

company fails, eliminating the desperate motivation that owners are supposed to feel when their

company struggles. In an article for Slate magazine, Daniel Gross illustrates that “businesses

with large debt loads often act with great urgency to restructure, to cut costs, and to rationalize

so they can be sure they have the cash to survive” (Gross). Typically, large debt levels would

back companies into corners where desperation kicks in, and growth and restructure would

occur by any means necessary. However, the Toys “R” Us’ owners lacked this desperation

because of the fees they paid themselves, which allowed them to limit their losses and be able

to remain afloat even if Toys “R” Us collapsed. Excessive fees may naturally accompany

leveraged buyouts, however, retailers need to be cautious to ensure that the fees they’re paying

are effective financial transactions that hold the fee recipients accountable.

Although the case of Toys “R” Us shines a negative light on leveraged buyouts, many

refuse to place all the blame on private equity because of its track record of successful business

turnarounds. Phil Wahba of Fortune magazine acknowledges it’s role in Toys “R” Us’ downfall,

but then expands his argument, stating, “private equity investors can offer retailers a huge boost

when things go right” (Wahba). Many retailers, such as Dollar General and Canada Goose,

have greatly benefitted from private equity purchases. The American Investment Council

published an article regarding Dollar General’s purchase by KKR in 2007, stating that, “Dollar

General has opened more than 2,000 new stores, created over 20,000 new jobs, and has grown

revenue by 56 percent” since it’s buyout (American Investment Council). Similarly, Wahba

asserts the buyout of Canada Goose by Bain Capital has “been both a grand slam for Bain and

a transformative deal for Canada Goose” (Wahba). KKR and Bain Capital, two of the three firms

involved in the Toys “R” Us, are established companies in the finance industry because of the
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successes they’ve had. Both firms would acknowledge the missteps that led to Toys “R” Us

downfall, but both would also acknowledge the opportunities that private equity investment can

provide for struggling companies. Harvard Business Review writers Felix Barber and Michael

Goold recognize the positives and claim, “Private equity will remain a financial tool because of

it’s “high-powered incentives both for private equity portfolio managers and for the operating

managers of businesses” (Barber and Goold). Private equity has provided the retail world with

successes and failures, with Toys “R” Us highlighting the failures, but it still remains a common

business practice. Toys “R” Us’ collapse certainly portrays private equity buyouts as dangerous,

but their frequent use and major successes will always remind people of the opportunities they

provide.

The shock that Toys “R” Us’ collapse managed to send throughout the retail world will

hopefully shine light on the dangers of private equity investment. Retail stores, particularly those

struggling and looking for outside help, need to recognize the implications of adding large

amounts of debt and uninvolved ownership, both of which private equity could potentially bring.

Despite it’s successes, the practice of utilizing leveraged buyouts needs to be scrutinized and

the private equity firms responsible need to be held accountable for their failures. With the

financial practice still prevalent in the U.S. and more and more retailers requiring outside

investment to fend off competition, it is now more important than ever to be aware of the

potential trickle-down effects that private equity funding and management can have. Toys “R” Us

employees are likely still feeling those effects, and the prevention of similar mass layoffs may

only be preventable by the employing corporations themselves. Private equity firms will continue

to swoop up struggling companies, but hopefully now the fate of Toys “R” Us, and its former

employees, will serve as a constant reminder to retailers of the risks that accompany those

swooping buyouts.
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Works Cited

Al-Muslim, Aisha. “Private Equity Prevalent in Retail Bankruptcies.” Newsday, Newsday, 21 Apr.
2017, www.newsday.com/business/analysis-private-equity-ownership-common-in-retail-
bankruptcies-1.13503349.

Appelbaum, Eileen, and Rosemary Batt. “How Private Equity Firms Are Designed to Earn Big
While Risking Little of Their Own.” LSE Business Review, The London School of
Economics and Political Science, 22 Jan. 2017, blogs.lse.ac.uk/businessreview/
2017/01/23/how-private-equity-firms-are-designed-to-earn-big-while-risking-little-otheir-
own/.

Barber, Felix, and Michael Goold. “The Strategic Secret of Private Equity.” Harvard Business
Review, Harvard Business School Publishing, 1 Aug. 2014, hbr.org/2007/09/the-
strategic-secret-of-private-equity.

Corkery, Michael. “Toys 'R' Us Says It Will Close or Sell All U.S. Stores.” The New York Times,
The New York Times, 14 Mar. 2018, www.nytimes.com/2018/03/14/business/toy-r-us-
closing.html.

Cummings, Chris. “Lawmakers Question KKR, Bain Capital Over Toys ‘R’ Us Failure.” The Wall
Street Journal, 6 July 2018.

Davies, Jessica. Bankruptcies bring risks of leveraged buyouts into focus. WSJ Pro.Private
Equity, Private Equity News, 4 July 2018.

Dalhoff, Denise, and Mark Cohen. “The Demise of Toys R Us: What Went Wrong.” University of
Pennsylvania Wharton, University of Pennsylvania, 14 Mar. 2018,
knowledge.wharton.upenn.edu/article/the-demise-of-toys-r-us/.

Gross, Daniel. “Why Best Buy Is Weathering the Retail Apocalypse and Toys R Us Isn't.” Slate
Magazine, The Slate Group, 19 Sept. 2017, slate.com/business/2017/09/why-best-buy-
is-weathering-the-retail-apocalypse-and-toys-r-us-isnt.html.

Isidore, Chris. “Amazon Didn't Kill Toys 'R' Us. Here's What Did.” CNNMoney, Cable News
Network, 15 Mar. 2018, money.cnn.com/2018/03/15/news/companies/toys-r-us-closing-
blame/index.html.

Kaplan, Steven N, and Per Strömberg. “Leveraged Buyouts and Private Equity.” Journal of
Economic Perspectives, vol. 23, no. 1, 2009, pp. 121–146. 1 November, 2018

Lachapelle, Tara. “Lessons Learned from the Downfall of Toys ‘R’ Us.” Bloomberg.com,
Bloomberg Businessweek, 9 Mar. 2018, www.bloomberg.com/news/articles/2018-03-09/
toys-r-us-downfall-is-ominous-reminder-about-debt-laden-deals.

Nicolaou, Anna. “Toys R Us Buckled under Private Equity Ownership.” Financial Times, The
Financial Times Ltd., 20 Sept. 2017, www.ft.com/content/
02a5edbe-9d93-11e7-8cd4-932067fbf946.
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Peterson, Hayley. “More than 3,800 Stores Will Close in 2018 — Here's the Full List.” Business
Insider, Bonnier Business Media, 8 Apr. 2018, nordic.businessinsider.com/stores-closing-
in-2018-2017-12.

Melton, James. “The Demise of Toys R Us Puts a Lot of Toy Sales up for Grabs.” Digital
Commerce 360, Digital Commerce 360, 30 Mar. 2018, www.digitalcommerce360.com/
2018/03/16/toys-r-us-puts-a-lot-of-toy-sales-up-for-grabs/.

“Toys Retail Sales Revenue in the U.S. from 2005 to 2017 (in Billion U.S. Dollars).” Statista,
2018, www.statista.com/statistics/195054/total-revenue-of-us-toys-and-games-market-
since-2005/.

Wahba, Phil. “Retail Reckoning: How Private Equity Is Boosting Some Brands and Crushing
Others.” Fortune, Time Inc., 24 Apr. 2018, fortune.com/2018/04/24/retail-private-equity-
investors-mall-shopping/.