FAO's Misfit Toy Biz

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The toys at FAO Inc.'s (Nasdaq: FAOO) FAO Schwarz stores are hardly misfits, but its business apparently is. The beleaguered retailer said on Friday that holiday sales haven't been up to par and, assuming trends continue, it could face imminent liquidity problems. It's also seeking a buyer.

Only a few weeks ago, the company denied it was in a cash crunch, saying in a press release, "The Company reaffirmed its earlier assessment of its liquidity provided in its quarterly report for the second quarter of the year, stating that it currently expects to generate operating income in the fourth quarter to offset losses typically experienced in the first three quarters of the year."

Clearly, FAO was counting on holiday magic to save the day, but judging by Friday's news, there's been no miracle on Fifth Avenue.

For many, what might be a bit misfit about FAO Schwarz toys are their prices. Despite what looks like an improving economy, we're still coming off a consumer cash crunch, and searching out bargains has become second nature to many. Given the company's problems over the last year, it has been in little position to engage in any price wars.

Wal-Mart (NYSE: WMT), meanwhile, has become a source for filling toy boxes, benefiting heavily from the discount draw. Others vying for toy shoppers include Toys "R" Us (NYSE: TOY), Target (NYSE: TGT), and even Sears (NYSE: S), through its partnership with toy retailer KB Toys.

A plan to install boutiques in Saks (NYSE: SKS) and Borders (NYSE: BGP) stores was a valiant effort FAO Schwarz planned to fund with additional capital, but a long-term recovery is looking like a long shot now.

According to Friday's release, the company's ability to carry on normal operations in November and liquidity in December -- the pinnacle month in holiday shopping -- depend on sales trends. Could it be that unfortunate investors will be the only ones left holding the FAO bag?

Alyce Lomax welcomes your feedback at alomax@fool.com.