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Remember, This Is What Actually Killed Toys R Us

By Motley Fool Staff – Updated Apr 16, 2019 at 10:32AM

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The company went bankrupt and closed its U.S. stores, but don’t blame the internet.

The death of Toys R Us did not come due to increased competition from the internet. It died -- at least in the United States -- because the company had a tremendous amount of debt due to a leveraged buyout used to take the company private. That stopped the retailer from investing in its stores at a time when demand faltered and major retailers lowered.

A full transcript follows the video.

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This video was recorded on Feb. 12, 2019.

Dylan Lewis: Dan, Toys R Us is one of those stories, kind of like Sears, it just keeps coming back. It doesn't seem to go away.

Dan Kline: Well, here's the problem. Toys R Us is a lost example. The company declared bankruptcy. When it declared bankruptcy, it had every intention of coming back under restructuring, and it wasn't able to work that out with its debt holders. That put it in a position where it had to close all its stores, give up its retail portfolio, miss an entire holiday season for the most part -- it had kiosks in some Kroger stores. And now, in the U.S. at least, it's starting from scratch. That's a very difficult position to be in, even if the company no longer has that looming debt that was sort of crushing everything it was trying to do.

Lewis: Before we get into some of the more recent developments with this company, it's probably worth giving a little bit of a history lesson with how we got there. You alluded to this. A lot of the current situation that we see with Toys R Us is the result of some of the leveraged buyout action that the company went through when it went from being a publicly traded company to a private company some years back.

Kline: Let's explain what a leveraged buyout is. A leveraged buyout is when a company buys another company, mostly using the company that they're buying to fund the deal. Toys R Us took on, I believe the number was $6 billion worth of debt, though it's been a while, I don't remember that exactly. In doing that, they entered a market where toy sales were slowing, they were going online, there was more competition from big-box retailers, and instead of being able to pivot and redo their stores, move to an omnichannel model, make the stores interactive, and add all sorts of fun stuff that kept Toys R Us at the head of the pack when it comes to toy stores, they did not have the money to do that because all their money went into debt servicing. It created a situation where the chain got old very quickly. It wasn't forced out of business because there was no demand for toys. It was forced out of business because it couldn't keep pace with where the market was going and make its debt payments.

Lewis: That's one of the major criticisms that people have of these LBOs. The company behind this one, KKR, is one of the most famous firms for this strategy. Anyone that has seen or read Barbarians at the Gate is familiar with this firm. It creates a lot of operational problems for the company that has been acquired because you're saddled with debt and really can't do a lot of the investments that you'd like to be able to put into your business to make sure that you're keeping pace with the trends in your industry.

Kline: It only makes sense in a market where there's incredible growth. This one happened at the sweet spot for a bad time. The industry had been growing, but Amazon hadn't quite stepped up yet. Almost the second this deal closed, all of a sudden, Toys R Us was faced with this massive new competition. The presence of Amazon actually forced Target and Walmart to lower prices for toys because toys became a draw to their stores, so they weren't going to make the same margin that Toys R Us needed to make on what was their only product.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Daniel B. Kline has no position in any of the stocks mentioned. Dylan Lewis owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends KKR. The Motley Fool has a disclosure policy.

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