
How vulture capitalists ate Toys 'R' Us - amyjess
http://theweek.com/articles/761124/how-vulture-capitalists-ate-toys-r
======
listenallyall
TOY shares had fallen from $40 to the low teens by 2004. By announcing a sale
of the toy business, the stock rebounded and ultimately the sale to private
equity closed at $26.75 per share. That Board knew they had a declining asset
on their hands and sold out, at a large premium, rather than watching their
equity slowly decline over the next decade.

Anyone who despises private equity should be celebrating this story, in this
case, KKR/Bain/Vornado were the suckers in the deal, they bought the rotten
apple and suffered massive losses because of it.

[https://www.nytimes.com/2004/08/12/business/toys-r-us-
says-i...](https://www.nytimes.com/2004/08/12/business/toys-r-us-says-it-may-
leave-the-toy-business.html)
[https://www.nytimes.com/2005/03/18/business/company-news-
toy...](https://www.nytimes.com/2005/03/18/business/company-news-toys-r-us-
accepts-66-billion-buyout.html)

~~~
metabagel
I think you may have missed the part where Toys 'R' Us' debt skyrocketed from
$109M to $5B due to the leveraged buyout. The interest on that debt as well as
the exorbitant management fees did Toys 'R' Us in.

[https://www.bloomberg.com/news/articles/2018-03-09/toys-r-
us...](https://www.bloomberg.com/news/articles/2018-03-09/toys-r-us-downfall-
is-ominous-reminder-about-debt-laden-deals)

~~~
JumpCrisscross
> _the exorbitant management fees_

These are charged to the fund ( _i.e._ the investors), not the company. PE
firms charge companies transaction fees. "Toys 'R' Us does say in its SEC
filings that $47 million in transaction fees that it owed KKR, Bain and
Vornado, have been waived. The advisory fees were also voluntarily reduced by
the investment firms in recent years" [1].

Private equity isn't VC. When a holding goes bust, the fund loses a _lot_ of
money. That, in turn, sharply limits what fund managers can do and how much
they can pay themselves, including from other better-performing investments.

[1] [https://www.forbes.com/sites/nathanvardi/2017/09/19/the-
big-...](https://www.forbes.com/sites/nathanvardi/2017/09/19/the-big-
investment-firms-that-lost-1-3-billion-on-the-toys-r-us-
bankruptcy/2/#785c558c73b0)

~~~
mbesto
> the fund loses a lot of money

This isn't equivocally true. It all depends on how levered the investment is
and how much debt they pulled off the books to pay back the banks (or their
fund). The stereotypical PE fund looks like this: buy company for $100M with
50% debt and 50% equity. Meaning, investment banks give them $50M to buy the
company at market rates and the PE firm spends the other $50M from their fund.
Load the company up with debt and then pay off the senior credit facilities
with the profits while the business slowly dies. In other words, it's very
possible that PE firms and their lenders earn profits even if their portfolio
companies go bankrupt.

In the case of Toys R Us specifically, it appears they did a 17%/63% levered
split...which frankly is exorbitant. Most market norms are more around 50/50:

 _sank $1.3 billion of equity into the takeover of the Wayne, New Jersey-based
toy company, financing the rest with debt, according to company filings._

[https://www.bloomberg.com/news/articles/2017-09-19/bain-
kkr-...](https://www.bloomberg.com/news/articles/2017-09-19/bain-kkr-vornado-
suffer-wipeout-in-toys-r-us-bankruptcy)

> That, in turn, sharply limits what fund managers can do and how much they
> can pay themselves

What are you referring to when you say "fund managers"? The LPs? The LPs are
super diversified, so that's irrelevant. The GPs make their base salary from
management fees and their bonus from carry on the return of the fund. The idea
that a fund "loses" money isn't that black and white...their are intricacies
into how this plays it out.

Source: Wife is a PE firm founder and I advise PE firms.

~~~
JumpCrisscross
> _The LPs are super diversified, so that 's irrelevant_

Losing a dollar is losing a dollar, diversified or not. The investors in these
PE funds lost money. Where they net out against other investments is
irrelevant.

> _GPs make their base salary from management fees and their bonus from carry
> on the return of the fund_

Salary, yes. But good luck earning any carry on this fund. (They'll be lucky
if DPI crosses 1x with a hole this big.) Agree that PE accounting is
complicated.

~~~
mbesto
> But good luck earning any carry on this fund.

Again, depends on who's left with the debt...the typical large cap PE playbook
is to hand the debt off to the company, while the PE firm and the senior debt
have been paid off by the time the company gets liquidated. I haven't reviewed
all of the financials and the SEC filings, but normally if you're levered at
63%, then it's likely they were able to pay off the equity in short order.

See case study here:
[https://d1ge0kk1l5kms0.cloudfront.net/images/G/01/books/stec...](https://d1ge0kk1l5kms0.cloudfront.net/images/G/01/books/stech-
ems/AnIntroToInvestmentBanksHedgeFundsPrivateEquity_Toys_R_Us._V201080539_.pdf)

 _Another trend that was gaining popularity in the private equity industry
involved rapidly accessing the capital markets after closing a deal to raise
cash to pay a large dividend to the private equity owners. Firms typically
used the debt markets to finance these dividends, creating more highly
levered, riskier companies. In some cases, dividends paid to private equity
firms within one year of their original investment equaled the original equity
commitment. In the Hertz LBO transaction, Clayton, Dubilier & Rice, Carlyle
Group, and Merrill Lynch collected $1 billion in bank-funded dividends six
months after buying rental car company Hertz for $15 billion.6 About four
months later, Hertz issued an IPO to pay off the debt and to fund an
additional dividend, resulting in total dividends paid to the owners that
equaled 54 percent of their original investment of $2.3 billion (still leaving
them with 71 percent ownership). Private equity funds also took cash out of
their portfolio companies to pay large “advisory” fees to themselves. These
fees exceeded $50 million on large transactions during the buyout phase and
annual fees often continued throughout their ownership._

In that same article they mention Toyr R Us had ~$600M in EBITDA in 2005 in
which they could have easily paid off at the initial $1.3B that the PE firms
put up in equity financing. They also paid 9x (!!!!) EBITDA for a
Retailer....that's a ridiculous multiple with highly unlikely outcomes for
multiple expansion. So you only have three options (1) debt pump and dump (2)
consolidate the back-office (3) buy add-ons.

This is all leads me to believe that the real suckers in this whole thing are
the current debtors. Pure speculation on my side, but I really believe that
Toys R Us was already on it's way out (e.g. Amazon). Bain/KKR trying to find
deal flow where none could be found, figured they had two viable intertwined
paths (1) try to sell it to Amazon (2) load it up with so much debt that if
they couldn't sell it to Amazon, they wouldn't lose money if they paid
themselves back before it went into bankruptcy.

Capitalists place bets in things that go down too.

PS - 1x DPI ain't terrible in a seller's market (which it has been for large
cap in the last 10 years). I'm not sure what KKR or Bain fund this deal came
out of, but the real truth will be in there.

------
ghaff
>In other words, if Bain, KKR, and Vornado had never come along, Toys 'R' Us
wouldn't be doing stellar, but it probably could've muddled through.

Maybe. It was already on a downward spiral. There's pretty much zero evidence
that, left as a public company, they'd have figured out a way to reboot. It's
not like there aren't plenty of other retail chains in dire straits.

~~~
spamizbad
In 2003, in the pit of a recession, Toys 'R' Us was still profitable. It got
caught flat-footed by the proliferation of Walmart/Target _and_ online sales
at the same time.

Bain and KKR's turn-round strategy was largely a joke: They basically floated
a bunch of trial balloons to the press, arguing that they weren't going to
just be a toy store anymore (basically become a walmart or target) but that
was scuttled. After that, they just decided to control costs as tightly as
possible. Very little innovation.

Prior to the buyout, there was a team inside Toys 'R' Us that was trying to
clone Amazon's e-commerce success. It died with the buyout. Bain and KKR
thought they had a better plan: they didn't.

~~~
JumpCrisscross
> _there was a team inside Toys 'R' Us that was trying to clone Amazon's
> e-commerce success_

If we flipped roles, with the team inside Toys 'R' Us trying to control costs
before the PE firms came in and tried to make Amazon competitor, it would
sound equally damning.

~~~
gascan
Would it? Has "control costs" ever worked out as a viable long term strategy
in a business that is rapidly losing market share to a sea-change in
competitors?

~~~
listenallyall
AMD's stock was under $3 when this article was published, in Oct 2014. Today
it is over $10.

[https://www.wsj.com/articles/overheard-amd-cutting-
costs-141...](https://www.wsj.com/articles/overheard-amd-cutting-
costs-1413585056)

~~~
gascan
Good point, although that wouldn't have meant anything if they kept plodding
along with the Bulldozer family. Cut costs + bring new Ryzen chips to market,
both parts were needed.

~~~
listenallyall
Of course... the cost-cutting just stops/reduces the bleeding, extending the
company's runway so that it can survive longer without running out of cash.
The company still has to come up with a new product or strategy, in AMD's case
it was Ryzen.

------
JumpCrisscross
> _if Bain, KKR, and Vornado had never come along, Toys 'R' Us wouldn't be
> doing stellar, but it probably could've muddled through_

I'm rarely a defender of leveraged buy-outs, but in this case, I think it was
a good thing. Private investors took a moribund business and attempted a
turnaround. If they succeeded, everybody would have won. If they failed, a
long and tortured slide into irrelevance got aborted and cut short.

~~~
Retric
A slowly dying company is still successfully serving some customers and
employing people. So, early failure really is worse for both society and the
companies workers. Further, leveraged buyouts are funded with loans, those
lending money also lose out.

~~~
lmm
> A slowly dying company is still successfully serving some customers and
> employing people.

An unprofitable company is an overall loss by definition - sure it's providing
some value to some people, but it's consuming more value than it produces.

Killing the company quickly frees up the things it was consuming to be used
for more productive things. Those buildings can be used for better businesses,
or replaced with housing or parks or what-have-you. Other companies can offer
better jobs to those workers (we're at close to full employment at the moment,
and declining companies are not fun or fulfilling places to work). Money that
was invested in that company can be put to more productive work in other
businesses.

~~~
Spooky23
This particular company was strategic as it served as a competitive
counterbalance to discounters and online stores.

The impact of the death of ToysRUs will be significant to the toy industry as
a whole, as Walmart/Target only devote a couple of hundred linear feet to
toys, and Amazon has killed the little shops that powered the long tail.

~~~
JumpCrisscross
A counterbalancing opinion:

"The departure of Toys 'R' Us from the retail landscape will give a boost to
neighborhood toy shops.

That’s according to the American Specialty Toy Retailing Association, which
predicted that 2018 will be the best year yet for neighborhood toy stores
nationwide as consumers flock to these stores in the wake of the closure of
Toys 'R' Us."

[https://www.chainstoreage.com/finance-0/group-predicts-
boom-...](https://www.chainstoreage.com/finance-0/group-predicts-boom-times-
local-toy-stores/)

~~~
citizenkeen
Anybody who has ever forgotten your child's friend's birthday laments the loss
of Toys R Us. Upon the closure announcement, I immediately added Picolo Mondo
to Waze.

------
dbatten
The author seems to be bending over backwards to make the buyers look like
evil masterminds that profited from running Toys R Us into the ground...

For example, he notes that they'll have to write off their investment in Toys
R Us, but makes it sound like they're making out like bandits because they got
$200 million in management/consulting fees out of the deal. So, they lost a
$6.6 billion investment, and made $200 million in management fees? Doesn't
sound like a very successful evil plot to me.

More importantly, what if this had been a success? What if they had bought
Toys R Us and orchestrated a phenomenal turn-around? Would this still be a
story? Would they be evil, but this time they'd be evil because they stole a
public company for pennies on the dollar (a la the Dell lawsuit) and made bank
when it returned to growth and profitability?

A significantly more dispassionate discussion about the debt burden that goes
along with a leveraged buyout would have been far more interesting to read.

~~~
bhouston
EDIT: This comment is wrong.

> So, they lost a $6.6 billion investment, and made $200 million in management
> fees? Doesn't sound like a very successful evil plot to me.

They only had to put up 20% of the 6.6B, thus $1.32B. The rest was put up by
bond investors I believe.

TRU was also paying upwards of $425M per year on the debt it had. Assuming
that 20% of that was to the holders of the $1.32B debt, you get $90M of
interest payments. Given that the LBO happened in 2004, there have been 13
years of interest payments, which totals now $1.1B roughly. I am unsure if any
principle was paid off, there are no details for that.

Thus $1.1B in interest + $200M in management fees = $1.3B of their investment,
discounting inflation adjustments.

Basically KKR, Bain and others are at least close to net zero even though they
caused TRU to fail completely.

Lastly, bankruptcy just means that it is insolvent, it doesn't mean that the
current debtors get nothing. If the debtors in this case had control over TRU
they can ensure it goes bankrupt early enough that it can cover the
liabilities to its debtors, namely themselves. If the debtors can get even 50
cents on the dollar, they are net winners.

~~~
harryh
_Assuming that 20% of that was to the holders of the $1.32B debt_

This is a very poor assumption. The PE firms bought equity in TRU, they are
not paid back in the same way and on the same schedule as holders of debt.

~~~
bhouston
You are correct, the relevant passage is here:

> The trio put up $6.6 billion to pay off Toys 'R' Us' shareholders. But it
> was a leveraged buyout: Only 20 percent came out out of the buyers' pockets.
> The other 80 percent was borrowed.

I misjudged, I thought all of it was borrowed, just 20% was from the LBO firm.

------
Animats
That article links to a much more important article: "What caused the retail
apocalypse?"[1] In the US, malls are dying, because the middle class that
supported them is dying off. Toys-R-Us operated in malls and sold non-
necessity goods. That business is dead.

The direction US brick-and-mortar retail is headed is dollar stores at one end
and luxury goods at the other, with little in between. Dollar General opens
about 900 stores a year.

[1] [http://theweek.com/articles/697378/what-caused-retail-
apocal...](http://theweek.com/articles/697378/what-caused-retail-apocalypse)

------
harryh
Contrary to what the author says the story about the leveraged buyout wasn't a
footnote or somehow buried. In fact most of the storied I read on the topic
mentioned the debt situation as a major factor in the bankruptcy. It's trivial
to find dozens and dozens of stories on the topic:

[https://www.google.com/search?q=%22toys+r+us%22+%22leveraged...](https://www.google.com/search?q=%22toys+r+us%22+%22leveraged+buyout%22)

------
arx1422
If the debt load was excessive on an otherwise OK business then the debt would
be restructured vs. putting the company into liquidation. The idea that absent
the debt Toys R Us would have figured out how to invest in innovation is
totally speculative. This is a badly reasoned article.

~~~
bluGill
That is partially up to the lenders though. The lenders have their input in
bankruptcy court, and if they tell the court they want their money the court
tends to listen. Lenders will generally agree to bankruptcy because it is
better to be paid off in the future than take what they can get now. If the
lenders don't think the company can actually find a way to pay off the debt
that might want what they can get now so they can put it to better use.

My understanding is the debt was so high the lenders figure anything that
happens is just throwing good money after bad.

------
platz
so then, why did the board of directors decide to put it up for sale?

Whenever these stories about buyouts occur, it is framed as the buying company
being the agent who has decided the future. e.g.

> if Bain, KKR, and Vornado had never come along

Why does no-one ever mention the board of directors who decide to put it up
for sale?

Are they not the true agents in this story?

> Toys 'R' Us wouldn't be doing stellar, but it probably could've muddled
> through.

------
spodek
Not sure if relevant, but it looked like the difference between most Toys 'R'
Us products and centuries in a landfill were about a minute of smile followed
by boredom.

Bright, colorful, and passive.
[https://duckduckgo.com/?q=toys+r+us+shelves&bext=lcl&atb=v11...](https://duckduckgo.com/?q=toys+r+us+shelves&bext=lcl&atb=v113-5&iax=images&ia=images&iai=https%3A%2F%2Fi.ytimg.com%2Fvi%2FutW4Wxw93lU%2Fmaxresdefault.jpg)

------
aklemm
Thought limited, my experience in Toys 'R' Us was that it was no more fun and
exciting then the toy aisles at Target. So how was a dedicated toy store going
to win that way? Compare that to shopping for home improvement; way more fun
at Lowe's than the junky/limited aisles at Target.

~~~
bluGill
They had a much larger selection that target. If you are looking for something
specific target is less likely to have it. If you are looking for a toy - any
toy - target will have something good enough.

------
reverend_gonzo
This is written as if the entire purpose of buying Toy R US is to drive it
into the ground.

Those buying it, and those providing the loans to buy it, lost a lot of money
on a bet that they could turn it around. They lost the bet, and so be it.

The previous shareholders got paid and were able to move their capital out
into something they believed would provide better returns.

Sure, a lot of people lost their jobs. On the other side, a failing business
that could likely not afford to pay well went out of business, and someone
else will come in, buy the property, and need new employees.

This isn't as bad as the article makes it out to be. If anything, its good
that capitalists tried to turn it around, quickly failed, and now everyone can
move onto other things.

Slowly fading into oblivion over decades is not a good thing either.

~~~
metabagel
We don't really know that they lost the bet. In fact, it seems equally, if not
more likely that they profited on the deal, by siphoning money out of the
company over the last 12 years. This is a good primer on how these firms
operate:

[https://www.rollingstone.com/politics/news/greed-and-debt-
th...](https://www.rollingstone.com/politics/news/greed-and-debt-the-true-
story-of-mitt-romney-and-bain-capital-20120829)

~~~
reverend_gonzo
Matt Taibbi should not be writing about finance at all.

You want someone who actually know's what they're talking about? Read Matt
Levine's writings on Bloomberg.

------
Paul-ish
Is there any analysis of leveraged buyouts over the last x years? Rather than
selecting the ones that end in disaster. For example the Dell buyout [1]
doesn't seem to have caused a catastrophe yet.

Purely anecdotally, but I am typing this on a Dell desktop and regularly use a
Dell laptop and I am very happy with both, I am particularly happy with their
Linux support.

[1]
[https://en.wikipedia.org/wiki/Dell#2013_buyout](https://en.wikipedia.org/wiki/Dell#2013_buyout)

~~~
merb
you can't compare the buyout of dell with toys 'R' us. I mean he actually got
a 75% stake out of the buyout which means that he actually used a lot of his
own cash to close the deal. Also after two years he could double the value of
Dell. Something that is just amazing. In 2015 he bought EMC and made the
biggest tech mergers in history. Dell now has 140.000 employees and has a
revenue of like 60 billion annualy.

I mean it's way harder to die if you combine dell, emc, pivotal, rsa and
vmware...

------
nasmorn
So they took a Company with 2.2b cash and cash equivalents private with just
1.3b of their own money. Man I need to network with gullible bankers too

~~~
airstrike
There's nothing gullible about this kind of lending. LBOs are announced daily
and cutting a 20-30% equity check is very common.

Most of the time people make money on them -- sometimes _a lot_ of money, if
the timing, the target, and the fit is right. This wasn't one of such cases.

------
panda888888
Are you guys not familiar with the "Barbarians at the Gate" story of what
happened with KKR & RJR Nabisco in the late 80s?

I highly recommend you watch the movie or read the book if you don't know
about it. The movie is excellent.

Knowing that sequence of events, I feel like people should have realized that
all of this would happen to Toys R Us.

------
whack
The article, beginning with the title, makes it seem as if "vulture
capitalists" were benefiting by feasting on Toys R Us. In reality, they lost a
big pile of money by buying a company for $1.3B, which eventually became
~worthless via bankruptcy. They made a bet which failed, and paid the price
for it, so I don't see any purpose in kicking them while they're down. I'm not
sure how much money the creditors lost, but they knew exactly what they were
getting themselves into, so it's hard to have much sympathy for them.

Presumably, these "vulture capitalists" could only afford to make such a bet,
because they had historically succeeded more often than they failed. If you're
going to deride Bain/KKR as being bad for the economy, because of this
failure, you should also have the intellectual consistency to compliment them
for their successes in previous leveraged buyouts.

------
notMick
This seems another vague anticapitalism story portraying the VCS as bad,
whereas they bought a stake in the company and tried to turn it around. They
also lost.

90% of new businesses fail - most often from not finding or
matching/addressing the market. The market also changes so anyone who doesn't
adapt end on the Darwinian company list.

------
8bitsrule
Funny. I thought Toys 'R' Us was vulture capitalism, along with Wal-Mart.

------
wnevets
Capitalists, you mean capitalists.

------
oceanghost
Competing against amazon with an animated Giraffe and a 3x markup was never
going to work. If anything I'm surprised they made it this long.

That is not to say that Bain, TPG, etc aren't objectively evil.

~~~
jcater
You're overstating the markup, and they've price matched (including Amazon)
for a while.

~~~
antris
"The guarantees typically require shoppers to provide proof of a lower
advertised price on an identical item in stock at a nearby competitor’s store
before a price match will be approved. However, many big-box retailers work
directly with manufacturers and sell products with unique model numbers. As a
result, the retailer can deny a price-match request, as no other store carries
an "identical" item. Other common reasons for denial: the competitor is not
"local," the ad lists a percent discount rather than a specific price, or the
customer doesn't offer acceptable proof of the competitor's price.[9] Even if
all criteria are met, retailers grant price-matching requests on a case-by-
case basis at the discretion of store employees."

[https://en.wikipedia.org/wiki/Price-based_selling#Price-
matc...](https://en.wikipedia.org/wiki/Price-based_selling#Price-
matching_guarantees)

