What's Next for Toys R Us After Filing for Chapter 11?

In this segment from Market Foolery, host Chris Hill and Motley Fool Hidden Gems' Abi Malin consider the unsurprising news that the nation's largest toy store chain has filed for bankruptcy protection. With upwards of 20 retailers already having filed for Chapter 11 bankruptcy this year alone, it's possible that the real surprise is that Toys R Us lasted this long in an e-commerce disrupted world -- though the company did have a long track record of winning in its niche. So what's next?

A full transcript follows the video.

This video was recorded on Sept. 19, 2017.

Chris Hill: Toys R Us, which is the largest toy chain in the United States, has filed for Chapter 11 bankruptcy protection. We were talking about this earlier this morning, not a surprise.

Abi Malin: Not a surprise in the slightest. More than 20 retailers have already filed for bankruptcy since the beginning of 2017, and I think this is sort of a sign of the times, honestly.

Hill: It is a sign of the times, and I get that, but part of me, and maybe this is my age, is a little amazed/impressed that Toys R Us has made it this long, that they have survived to this point for this long.

Malin: Yeah, I would agree with that. I think previously, they were thought of as this category killer, because they had this huge specialty store with low prices, and they squeezed those independent shops. But now we're seeing the flip side with the Amazons (AMZN -2.56%), Wal-Marts, Targets squeezing Toys R Us. And I think they also had a pretty wide selection with the depth of products, so they were thought of as the last place to get the hot toy right before Christmas, that was sort of an advantage for them. And they also had a pretty good track record of identifying hits on toys well before their arrivals. So it was a combination of things, but we've seen that deteriorate over time.

Hill: And they have fended off competition in the past. Primarily what I'm thinking of is in the late '90s with the dot-com explosion, there was a company called eToys, which was essentially the Amazon for toys, because back then, Amazon was really overwhelmingly books and music. And eToys comes in and people were like, oh my goodness. And eToys was one of those IPOs -- if eToys went public today and had the IPO that they had back then, we would just be scratching our heads. I think eToys went public at $20 and closed the opening day at something like $75. It was some insane valuation for eToys. And I'm not going to go through the history of eToys, but the way that ended up was Toys R Us ended up buying eToys for essentially a ham sandwich. So, where are we now in terms of where this business goes from here? The chairman and CEO was very quick to come out and put as positive a spin on this as you can when you're announcing bankruptcy protection, because we're heading into the holiday season. This really should be the great three to four months for this business, and he came out and said, "This is the beginning of a new era for us and I want to let everyone know we're going to still be open through this." I don't know, I have not hesitated in the past to go to Toys R Us when I've been in the neighborhood of one. I don't know, on a gut level, I look at this now and think, "I'm not sure I want to do this."

Malin: They were purchased for $6.6 billion in 2005 by KKR (KKR -0.78%), Bain, and a real estate investment group called Vornado Realty Trust. They experienced growth for a couple of years. They actually filed for an IPO in 2010. And the finance situation weakened, so they pulled back from that. I think we've seen it with a lot of private equity deals that these companies are pretty leveraged, so they haven't had a ton of capital to reinvest and keep up with their competitors. So a lot of the critics have said that they're really slow to get into e-commerce and they've been slow to compete with Amazon and things like that. And I definitely agree. I think making a smaller store base, which is what they've talked about, keeping everything open through Christmas and then scaling back, makes sense. And I think another strategy they've been talking about is making a more experienced-based store. So, having in-store play areas and stuff like that. If you look at successful retailers and brick-and-mortar stores today, you think, Ulta. So, borrowing from that sort of, trying products before you buy them, and having the mix of high and low. I think it could be positive for Toys R Us, but it's definitely going to be harder than it would have been had they done this 10 years ago.

Hill: Yeah. For every example of a private equity firm -- this is not a knock on the firm you mentioned, but I feel like any time there is a successful move by private equity, there are also moves like this, examples where you can point to and say, "Oh, maybe in hindsight, loading Toys R Us up with debt was not the best move here."

Malin: Right, definitely.