I don’t wanna grow up, I’m a Toys ‘R’ Us kid, they’ve got a million toys at “Toys ‘R’ Us that I can play with”
When I was a kid in South Jersey, there was nothing better than a trip to the Toys ‘R’ Us store. Come the holiday season, my brother and I would nag Ma and Pa Roy non-stop to take us. So, when I heard in 2017 that Toys ‘R’ Us was on the verge of bankruptcy, the kid in me was crushed; the bankruptcy attorney in me was not the least bit surprised.
Brief History of Toys ‘R’ Us
Toys ‘R’ Us was founded in 1948 by Charles Lazarus when he returned home from World War II. Lazarus recognized the coming post-war “baby boom” and was eager to cash in. The company he founded started as a baby goods and furniture store called Children’s Bargain Town in Washington D.C. Though Lazarus originally focused on furniture and strollers, he soon became interested in the toy business. Lazarus noticed that parents frequently visited his store to purchase the latest toys and stuffed animals. He explored the idea of opening a store dedicated to toys, which were more profitable than furniture.
In 1957, Lazarus opened his first Toys ‘R’ Us in Rockville, MD. Toys ‘R’ Us expanded to suburban shopping areas across the US.
In 1966, Lazarus sold the company to Interstate Stores, Inc., a holding company for a chain of small department stores, to help finance a national expansion. With that sale, Lazarus transitioned from chief executive to head of the Toys ‘R’ Us division, which was already thriving. The company created the Geoffrey the Giraffe store mascot and introduced the “I’m a Toys ‘R’ Us kid” jingle.
In 1974, Interstate filed for bankruptcy. Lazarus handled the restructuring process, selling off struggling components of the business. He was successful and took the company public in 1978. A clothing store spinoff named Kids ‘R’ Us opened in 1983 and initially succeeded.
In 1994, Lazarus stepped down as CEO, which led to a series of management changes. Another spinoff, Babies ‘R’ Us, was later opened.
In the early 2000s, Toys ‘R’ Us opened the biggest toy store in the world in Times Square, which featured an indoor Ferris wheel. However, during this period, the company also began to see competition from Walmart and Target. This led to the closure of Kids ‘R’ Us.
In 2005, private equity stakeholders purchased Toys ‘R’ Us for $6.6 billion, taking the company private. The plan was to boost Toys ‘R’ Us’ sales and position the company for an IPO that would create a return for investors.
In 2009, with the private equity stakeholders now calling the shots, in an effort to compete in the e-commerce marketplace, Toys ‘R’ Us purchased Etoys.com and Toys.com. This proved to be too little too late, and in 2010, due to slumping sales, the prospect of an IPO was shelved.
In 2015, Dave Brandon, formerly of Domino’s Pizza, was installed as CEO, Toys ‘R’ Us’ fourth CEO in sixteen years.
Nothing helped to turn the fortunes of Toys ‘R’ Us around, as Walmart, Target and Amazon continued to erode its share of the marketplace, and in 2017 it was forced to file Chapter 11 bankruptcy.
What Caused the Bankruptcy
In its initial bankruptcy court filings, Toys R’ Us, like so many other brick and mortar retailers, laid the blame for its failings on its inability to compete with the low prices being offered by the likes of Amazon and Walmart. However, it was just not poor timing, or internet shopping, that were the causes. Toys R’ Us’ troubles could also be blamed on the debt load placed on it. Prior to being the purchase, Toys R’ Us was servicing secured debt of only $1.86 billion, a considerable amount, but with $11.2 billion in yearly revenue, manageable. After the deal, it was forced to service more than $5 billion in secured debt, making innovation and even ordinary maintenance near impossible. According to Bloomberg, by 2007, interest payments consumed almost 97% of Toys ‘R’ Us’ profits.
Toys “R’ Us was hardly the only retailer to run into trouble during the late 2010s. In 2017 alone, nearly 7,000 stores closed, spelling the loss of more than 50,000 jobs. Quite a few of these failed retailers were also owned by private-equity firms, with similar business models: buy a solid but struggling company, saddle it with debt, take enormous fees, and then get out when the time is right.
Import Aspects of the Bankruptcy Case
On September 19, 2017, Toys ‘R’ Us and its subsidiaries filed Chapter 11 bankruptcies in the Eastern District of Virginia. The basic objective of the Chapter 11 bankruptcy process is to stabilize the finances of a debtor’s business and restructure its debts with the goal of exiting as a financially healthier and viable business. Generally, in a Chapter 11, a company’s existing management remains in place. However, for a company the size of Toys ‘R’ Us, the Chapter 11 process can be extremely complex. Toys ‘R’ Us hired Kirkland & Ellis, LLP, a multinational law firm, to represent it in the case. At the time it filed, Toys ‘R’ Us operated nearly 1,600 stores in 49 states and 38 countries, employing 64,000 people worldwide.
An early issue in the case, one that received quite a bit of attention in the industry, and particularly from insolvency professionals in the New York/New Jersey metro area, was why Toys ‘R’ Us elected to file bankruptcy in the Eastern District of Virginia, rather than here in New Jersey, where the company was headquartered, or the Southern District of New York or Delaware, which are popular places for companies to file. Under the Bankruptcy Code, companies are allowed to file in any judicial district in which their domicile (i.e., place of incorporation), residence, principal place of business, or principal assets have been located for the 180 days prior to filing. However, the Bankruptcy Code also allows a company to file in a district where they have an “affiliate,” which is how Toys ‘R’ Us was able to file in Richmond, VA.
While technically able to do it, the question was why? According to industry experts, the reasons for selecting the Eastern District of Virginia were threefold: (1) a “rocket docket,” the bankruptcy court in Richmond had demonstrated an ability to administer cases quickly; (2) an expertise in large and complex cases; and, perhaps most importantly, (3) a willingness to approve and award exorbitant fees to the professionals retained in the case. Unlike in other areas in the law, Bankruptcy Courts are required to review and approve the fees being charged by the professionals representing the debtor company. In the Toys ‘R’ Us case, lawyers from Kirkland & Ellis indicated to the court that they were charging as much as $1,745 per hour, a rate 25% higher than the highest rate in 10 of the largest bankruptcies filed in 2017. In fact, the Bankruptcy Court ultimately awarded Kirkland & Ellis $56 million in fees for its work in the case. Turnaround specialist Alvarez & Marsal was awarded $44 million in fees.
Almost immediately upon filing for bankruptcy, Toys ‘R’ Us was able to secure $3 billion in a DIP (Debtor in-Possession) financing to keep operating, pay the expenses associated with the bankruptcy, and rebrand. DIP financing is different from other financing methods in that it usually has priority over existing debt, equity and other claims.
However, while the influx of new money provided some immediate stability, it did not solve the company’s most important problem: lagging sales due to an inability to compete on prices with its competitors. Also, as soon as the bankruptcy was announced, consumers stopped purchasing gift cards –an important source of revenue — likely believing that the cards would be worthless if the company stopped operating. In most bankruptcy cases, a retailer must request special permission from the Bankruptcy Court to be able to honor its gift cards; otherwise, they are simply unsecured debt, which, in most bankruptcy cases, receives little or no repayment. The company was also hampered during the 2017 holiday season by IT problems that resulted in shipping delays and lost sales.
By 2018, it was clear that Toys ‘R’ Us had no plan entering bankruptcy to reduce costs by quickly closing non-performing stores, or renegotiating its existing debt, having filed before negotiating with its creditors. In bankruptcy, a debtor like Toys ‘R’ Us has the prerogative to assume leases for stores or locations where business operations are profitable and reject those that do not contribute to a debtor’s profitability. If a debtor
elects to assume a lease, it must pay the landlord for all delinquent amounts owed and “cure” any other lease defaults prior to assumption. However, when a debtor rejects a lease, the lessor is only entitled to an “unsecured” claim for damages, which often receive pennies on the dollar.
In 2018, Toys ‘R’ Us announced its plan to close at least 180 of its locations, 20% of its total stores, with the intention of eventually closing hundreds more. This turned out to be too little too late.
In 2018, Toys ‘R’ Us’ lenders, citing the company’s failure to meet sales and profit targets in the fourth quarter of 2017, which triggered covenant defaults, determined that their best path to recouping at least some of the money they loaned, forced the company into liquidation. This decision resulted in the closure of all 800 US stores and the layoff of 33,000 employees.
The Bankruptcy Code provides for the sale of property of a debtor in bankruptcy. However, the sale of property that is not in the ordinary course of the debtor’s business requires notice to creditors and parties in interest and approval of the bankruptcy court. In fact, as bankruptcy sales have become the norm, Bankruptcy Courts have allowed for more traditional acquisition techniques to maximize value in reorganization and liquidation cases. These techniques, including auctions, customary acquisition agreements, use of financial advisors and payment of break-up fees, have made investing through the bankruptcy sale process more efficient. In addition, bankruptcy courts can assure purchasers, under the proper circumstances, that assets may be purchased free and clear of encumbrances and that successor liability may be minimized, thereby adding value to the assets being sold by the debtor. Thus, these sales create significant strategic and financial opportunities for investors.
For example, during the case, Toys ‘R’ Us was able to obtain court approval for the sale of its corporate complex in Wayne. The 193-acre site was purchased for $19 million, even though the property had an estimated market value of $94.1 million at the time. In addition, the debtor was able to sell its 82 Canadian stores for more than $230 million.
New Toys ‘R’ Us
What was not sold in a similar fashion, was the majority of Toys ‘R’ Us’ intellectual property, including brand names Toys ‘R’ Us, Babies ‘R’ Us, registry lists, website domains and Geoffrey the Giraffe. These assets were retained by the company’s lenders who determined that they would be better off establishing a “new independent U.S. business.” The lenders ultimately created TRU Kids Inc., which was led by CEO Richard Barry, former global chief merchandising offer of Toys ‘R’ Us. Tru Kids ultimately opened two stores in 2019, one in Houston and one in the Garden State Plaza in Paramus. Both stores closed in 2020 due to week foot traffic and the pandemic.
But that is not the end of the story. In March2021, WHP Global, a leading brand acquisition and management firm, acquired a controlling interest in Tru Kids. WHP also owns name brands Anne Klein and Joseph Abboud. This past summer, WHP announced a partnership with Macy’s, Inc. in connection with the Toys ‘R’ Us brands. According to press releases, the plan is to have Toys ‘R’ Us products available for sale online through Macy’s, as well as Toys ‘R’ Us shops within Macy’s locations in 2022. Also, and probably most exciting, at least for this Toys ‘R’ Us kid, is the new Toys ‘R’ Us megastore that opened in the American Dream Mall here in northern New Jersey, right before the holidays.
