The way Toys "R" Us (NYSE:TOY) is sticking its neck out, it's appropriate it has a giraffe for a mascot. The stock is trading for just a quarter of what it was fetching ten years ago, and poor Geoffrey the Giraffe will need those long legs to walk past the elephants' graveyard littered with the remains of fallen toy retailers like FAO Schwarz, Noodle Kidoodle, and Lionel Playworld.
Here we are, days away from kicking off what's shaping up to be the best holiday shopping season in years, and Toys "R" Us is scaling back and hunkering down. In a market that's been in a forgiving mood after a year of gains, this company is that rare lump of coal -- a recognized juggernaut trading for less than ten times what it will earn this year.
Investors are angry. Analysts are foaming at the mouth. But before you burn that plush toy in effigy or hurl Molotov Lincoln Logs at a seemingly defenseless superstore, there are a few things that might just change your mind.
I believe in Toys "R" Us. Maybe you will too.
Slamming Sam
When you trace the path of the toy retailer's perdition, all roads lead to Wal-Mart (NYSE:WMT). It's been years since Sam Walton's discount department store behemoth lapped Toys "R" Us to become the country's leading seller of playthings. Just as Wal-Mart has become a thorn in the supermarket industry's side as it widens its grocery offerings, once the low-cost Walton empire commoditizes your niche it's reasonable to tremble and adjust your Depends.
But, hold on a minute. A recent article in Fortune argues that the only company Wal-Mart fears is the similarly shrewd cost-cuttering warehouse-club operator Costco (NASDAQ:COST). It's a great read but under that type of reasoning it would seem as if the only way to truly matter again would be to limit product markups to 14% and sell Barbies and GI Joes by the gross.
That would be depressing -- if it were true. The fact is, Costco isn't the only retailer thriving while grazing away at Wal-Mart's turf. Wal-Mart offers discounted Internet access and online DVD rentals, yet trails market leaders America Online (owned by Time Warner (NYSE:TWX)) and Netflix (NASDAQ:NFLX), respectively, by an Arkansas mile. Sure, the super retailer has aisles of books and magazines, but that hasn't exactly slowed down the steady growth of Barnes & Noble (NYSE:BKS).
Why? Because Wal-Mart is too big to re-brand itself as a retailer on the leading edge of technology, or too centered to carve out crucial selling space to jam a cappuccino-pouring barrista in a sea of cozy reading chairs and mahogany.
That's how you beat Wal-Mart. You aim for the knees. Toys "R" Us will never be cheaper than Wal-Mart, but, by the same token, Wal-Mart's toy area will never be fun. Ever. While Toys "R" Us tries with a few hands-on toy testing areas and a calendar ripe with low-key arts and crafts activities, this should really be so much more. The stores need to be truly magnetic to draw both kids and parents deep inside and milk out the impulse purchases. Why not lift a page from the fast food playbook and set up elaborate tunnel and ball crawl playgrounds towards the back? Forget trying to convince dad to pack the kids in the car and make that two-mile drive just so junior can play with construction paper and a glue stick. That's never going to work. Go for the destination jugular by offering up real entertainment like upscale puppet shows and character parties, and get those toy makers to pony up for sponsored contests with attractive door prizes.
Sharper thinking
Sharper Image (NASDAQ:SHRP) used to struggle with a low traffic-conversion rate as everyone loved to kick the tires of its big-ticket wares before moving on to the mall's food court empty-handed. Then the company discovered the joys of selling exclusive gadgetry, and the world of high-tech gizmos and air purifiers has never been the same. It makes a huge difference when you're the only seller of a particular product. Not only has Sharper Image been able to grow its sales but it has also grown its margins since it doesn't have to necessarily compete when it comes to pricing its exclusive merchandise.
Yes, Toys "R" Us has done this in the past. But it's usually an obscure video game or an indistinguishable remote-controlled car and it is never marketed well enough to educate consumers in terms of the item's exclusivity. If a company mailer is going to be nothing more than a list of popular toys that are available everywhere else it might as well see if Wal-Mart wants to pick up the tab because that's really who it would be advertising for. Be original, Toys "R" Us. Be exclusive.
Better yet, bankroll a search for the next great toy. Scour the country looking for the greatest toy inventors of all ages, milking the tour with publicity-hogging antics. You can narrow the field of entrants and then feed the American Idol frenzy by having the consumers vote for the ultimate winner. Then you could roll out the ultimate exclusive toy line to hungry inclusive buyers. You can even play up the grass roots angle by singling out local honorable mentions with limited rollouts that would assure getting to third base with the local media.
Building blocks
Wal-Mart's a big beast with sharp teeth but it's also on a short leash. To trump the methodical you have to be creative. For a company that has spent decades understanding toys and games, having a little fun should come naturally.
That's why I believe in Toys "R" Us. No, I don't think it gets it just yet. While I agree with its move in closing Kids "R" Us -- it never really belonged in the cutthroat space of standalone apparel retail -- I think it should have kept the freestanding Imaginarium outlets as incubators for its more inventive future.
I like its move to outsource online operations to Amazon (NASDAQ:AMZN) as it did three years ago, but I may never rest easy with its highly leveraged balance sheet. So, is it wrong to have faith in a company not so much for what it is today but for the logical sequence of realization that will make it great come tomorrow?
Shopping early has its benefits. Over the holidays, it's also when the best deals are to be found.
Rick Aristotle Munarriz is a regular Toys "R" Us shopper. Rumor has it that he was that way even before his two sons were born. He doesn't own shares in the company but he may if the stock continues trading in its pre-teen ways. He does own shares of Netflix, though. Rick's stock holdings can be viewed online, as can the Fool's disclosure policy.
