That's No Fun: Why Toys "R" Us Filed for Chapter 11

In this segment from the Motley Fool Money radio show, host Chris Hill, Million Dollar Portfolio's Jason Moser, Total Income's Ron Gross, and Motley Fool Pro and Options' Jeff Fischer consider the decline and fall of that icon of childhood, Toys R Us. And while it's true that kids are losing interest in toys faster as electronic devices capture their attention earlier, and also true that Amazon.com (AMZN -1.11%) and its ilk are soaking up sales, what really put this company into the penalty box was the choice by its private-equity owners to lard it down with debt.

A full transcript follows the video.

This video was recorded on Sept. 22, 2017.

Chris Hill: Retail news this week that may not have been surprising but was still a little bit jarring: Toys R Us filed for Chapter 11 bankruptcy protection. CEO Dave Brandon says the stores will still be open through the holidays. They've just got too much debt, Jason.

Jason Moser: It feels like they're taking a little bit of our childhood away from us.

Hill: That's what I'm saying! It kind of hit me on a gut level.

Moser: It's a bit sentimental, I guess. I mean, listen, there are a lot of takeaways on this. But ultimately, in the end, when you have a company that is devoting a lot of financial resources to a questionable strategy, and they just keep on growing that debt, I mean, it's really difficult to overcome that in the face of a market that's changing very quickly. Not only the proliferation of e-commerce, but really, we think about how toys have become something different today. The definition of a toy is much different today than it was when we were growing up. There's a much smaller window there for kids before they start graduating to those devices.

You're right -- Toys R Us is not going away. Wall Street banks are out there providing some lending there. And I think a lot of that is based on the perceived value of some real estate out there, what we called the Arrested Development thesis. There's always money in the banana stand. The problem is, you'd better be good at valuing that real estate, or it'll come back and bite you. We've seen that happen with Sears already. So, as Ron always asks with J.C. Penney, does the world really need Toys R Us? I'm thinking, right now, probably not.

Ron Gross: It's interesting that you say that. A few years ago, the one nearest to my home closed. It was because the strip center was turning over and being deconstructed, for lack of a better word. And people didn't miss a beat. In the day of Amazon, where you can order eight things and return seven of them free of charge, you don't need that big-box toy retailer.

Moser: Digital content, social media, all of those substitutes out there competing for those kids' attention. It's a much different landscape today.

Jeff Fischer: A trip down memory lane. Circuit City, Linens & Things, A&P, Blockbuster, Radio Shack --

Gross: We're old.

Fischer: -- Borders. [laughs] Did I say Sports Authority? Sbarro Pizza. All these retailers that have gone bankrupt in the past five to 10 years. And it just points to these companies are operating on such thin margins. You have high expenses. You're so dependent on steady traffic. And if you start to take on debt, it's just one missed step and you're in trouble.

Hill: Although give Toys R Us credit for making it this far. You go back to the late 1990s, and a little company called eToys, which had this blockbuster IPO. At that point in time, there were plenty of people on Wall Street saying, "Toys R Us is doomed." And it was just a matter of a few years --

Fischer: And they were right. [laughs]

Hill: Well, they were right eventually, but it was just a matter of a few years before eToys was the one going down. And in fact, Toys R Us bought them for the inventory.

Moser: You can tie this back to a couple of public companies. We get a lot of questions regarding Hasbro (HAS -0.38%) and Mattel (MAT 0.45%), and how this affects those companies. It's interesting to see, when this announcement was made, Hasbro's stock actually traded up. But Toys R Us is not really essential to either one of those businesses. Mattel comes out on the short end of the stick, as they have more on the receivables line than Hasbro does. But ultimately, with Wal-Mart, with Target, with Amazon, there are a lot of different ways to fill in that void that Toys R Us may very well leave.

Hill: That's true, although this will be one to watch for the next 12 months or so. I think, certainly, when Sports Authority went down about 15 months ago, there were plenty of people saying, "Boy, this bodes well for Dick's Sporting Goods. This bodes well for Nike and Under Armour, because they're building out their own e-commerce lines." And all three of those have struggled since then.

Moser: Yeah, they definitely have. In the near term, they have suffered greatly.