Toys “R” Us Files for Bankruptcy

The term “Too Big to Fail” is synonymous with the mortgage and banking industries but it can be applied to other major companies in the increasingly online retail-centric age. Toys “R” Us’ bankruptcy filing this past week is a cautionary tale highlighting both the dangers of taking on excessive amounts of debt in order to grow and bricks-and-mortar retailers not taking the online retail phenomenon seriously enough. Additionally, the bankruptcy demonstrates the changing dynamic of kids’ buying habits, away from traditional toys towards electronics, video games, smartphones and tablets, all products perfect for online retail.

The stakes are high with an estimated 14 percent of all toy sales already being made online, up nearly seven percent from just five years ago. And Toys “R” Us is not alone in retailers filing for bankruptcy. In the past year a number of high profile chains have also filed for bankruptcy, including Payless shoes, children’s clothing retailer Gymboree, teenage clothing retailer rue21, and Perfumania. Increased online/bricks and mortar competition from the likes of Amazon, Walmart and Target have also contributed to the toy giant’s demise.

While the company’s European and Australian operations are not affected by the bankruptcy declaration, what is still unclear is the fate of its 64,000 employees and 1,600 stores. But there are contributing factors that make Toys “R” Us’ situation a stern warning to other companies looking to grow at considerable risk. The company has massive debt problems.

Last year the company reported a loss of $29 million. With more than 100,000 creditors, the company’s bankruptcy filing list $6.6 billion in assets but $7.9 billion in debt. In its current fiscal year which ends in January 2018, the company had $444 million in debt coming due in connection with its 2005 leveraged buyout. In the following year the company has a massive $2.2 billion in maturing debt.

On the positive side, $3 billion in financing has apparently been agreed upon by a group of lenders fronted by JPMorgan Chase to keep the lights on and pay suppliers. However, to compound matters, the all-important holiday season is fast approaching and the company makes a large percentage of its annual sales in the holiday season each year. This year though there have been problems.

With rumors of an impending bankruptcy rife, the company’s toy suppliers are understandably skeptical about its ability to pay invoices months later. As a result, nearly 40 percent of the company’s domestic and international suppliers are demanding either cash in advance or cash on delivery. The company said that translated into an extra $1 billion in liquidity needed for the holiday season. Money the company simply didn’t have, expediting bankruptcy protection.

The lessons learned for major bricks and mortar retailers is clear. While they need both a physical and a strong online retail presence, the question is how to pay for it. Toys “R” Us says the bankruptcy filing will help it cut costs and compete with eCommerce, along with allowing it to invest in long-term growth.

Increasingly, having both an online as well as a bricks and mortar presence is seen as an asset and not a detriment. Having physical stores and increasing number of distribution centers brings retailers closer to their customers, as well as reducing online shipping and return costs.

That said, the Toys “R” Us story carries a major warning to other bricks and mortar retailers which inevitably have to make the business transition to online retailing as well. Too much debt can bring with it too high repayment costs that can’t be met with sales. And yet the conundrum is that bricks and mortar stores have to embrace the online retailing world or face the very real risk of going under.

Toys “R” Us’ bankruptcy filing is likely to be the first of many as big retail chains seek to effectively compete in a future retail environment that inevitably combines both bricks and mortar stores and online retail sites.

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