Story of the year: Toys R Us and the retail apocalypse

When Toys ‘R’ Us filed for Chapter 11 bankruptcy in 2017 – which ultimately led to more than 30,000 workers out of a job – the retailer was paying $400 million in annual interest on $5.5 billion of debt, hampering its ability to compete with internet giants, court papers show.

The $6.6 billion acquisition of Toys “R” Us by Bain Capital, KKR and Vornado Realty Trust in 2005 was financed with only $1.3 billion of equity, according to Toys ‘R’ Us’s 2005 annual report filed with the Securities and Exchange Commission. Court filings indicate this to be a factor in the store’s downfall.

In September KKR and Bain announced the creation of a $20 million severance fund to provide compensation to the more than 30,000 workers who were left without severance after Toys ‘R’ Us’s liquidation in March. The firms each contributed $10 million to the fund, with none of the capital coming from limited partners.

Household retail names, many owned by private equity firms, have been casualties in recent years as the industry faces an uncertain future.

Consumer retail deals done from 2005-09 have a write-off rate of 11.4 percent, according to data from analytics firm CEPRES. From 2010 to present, the write-off rate is only 1.5 percent.

Fickle customer tastes, the growth of Amazon and niche online retailers and over-expansion have turned out to be real challenges, and maybe even existential threats, for companies once seen as solid bets. Those factors don’t discriminate by balance sheet or whether a company is backed by a private equity firm.

“People who bought in [did so] when retail was good cashflow, it was relatively easy to grow each year and add new locations,” says Al Koch, managing director at turnaround specialist AlixPartners, who has helped turn around many major retailers. “What was a pretty safe investment isn’t a safe investment anymore.”

Although we’ve seen portions of this movie before – the GFC, for example, claimed many different retail victims – this time is worse.

Retail sector defaults stood at 8.2 percent in 2017, up from 5.7 percent in 2009, and 2018 is likely to be similar. Portfolio companies like Sycamore Partners-backed Nine West Holdings to Apollo-backed Claire’s Stores are among those seeking court protection.

However, distressed debt firms are much more adept during this retail downturn, Gregory Plotko, a partner at law firm Richards Kibbe & Orbe specialising in bankruptcy, observes.

“There’s a lot more players willing to get into credits at different parts of the capital structure,” he says. “That has led to the increased use of pre-planning restructuring support agreements and making further investments through the use of rights offerings within a bankruptcy case.”