Saturday, March 17, 2018

"How Vulture Capitalists Ate Toys 'R' Us"

From The Week:
Just a few years ago, Toys 'R' Us was an iconic American retailer. Six months ago, it filed for bankruptcy. Two days ago, it announced that all 800 of its American stores, and all 100 of its British ones, are closing or being sold. As many as 33,000 workers could lose their jobs.
What happened to America's biggest toy store?

Simply put, vulture capitalists ate it.

Our story begins in 2004. After big success in the 1980s, Toys 'R' Us' performance turned lackluster in the 1990s. Sales were flat and profits shrank. Toys 'R' Us was a public company at the time, and the board of directors decided to put it up for sale. The buyers were a real estate investment firm called Vornado, and two private equity firms named KKR and Bain Capital. (You may remember the latter from 2012 campaign ads: It was co-founded by former Republican presidential candidate Mitt Romney, though he'd moved on well before this.)

The trio put up $6.6 billion to pay off Toys 'R' Us' shareholders. But it was a leveraged buyout: Only 20 percent came out out of the buyers' pockets. The other 80 percent was borrowed. Once Toys 'R' Us was acquired, it became responsible for paying off that massive debt burden, while also paying Bain Capital and the other two firms exorbitant advisory and management fees.

In theory, everyone wins in a leveraged buyout. It's supposed to take an ailing company private and retool it into a leaner and more effective business. Then it's sold back to public shareholders for a profit. The buyers make money; the shareholders get a healthier business; the workers stay employed.
What actually happened was Toys 'R' Us continued to stagnate. The company never really figured out how to respond to the changing market, or the rise of online retail. And it missed out on some opportunities, like licensing the Star Wars and Lego movie brands. Meanwhile, rising inequality and wage stagnation ate away at the broadly distributed middle-class consumer base that Toys 'R' Us and other retailers traditionally relied upon.

Whatever magic Bain, KKR, and Vornado were supposed to work never materialized. From the purchase in 2004 through 2016, the company's sales never rose much above $11 billion. They actually fell from $13.5 billion in 2013 back to $11.5 billion in 2017.

On its own, that shouldn't have been catastrophic. The problem was the massive financial albatross the leveraged buyout left around Toys 'R' Us' neck. Just before the buyout, the company had $2.2 billion in cash and cash-equivalents. By 2017, its stockpile had shriveled to $301 million, even as its debt burden ballooned from $2.3 billion to $5.2 billion. Meanwhile, Toys 'R' Us was paying $425 million to $517 million in interest every year....

For another, larger ($20 billion total debt) example see Thursday's "Largest Radio Station Owner, iHeart Media (finally) Files For Bankruptcy Protection (iHRT)".

And then there's 2011's "The Porn Shop Operators Strike Again: Harry & David files for bankruptcy";
``You can sell it to Berkshire, and we'll put it in the Metropolitan Museum; it'll have a wing all by itself; it'll be there forever,'' he says at the February meeting. 
``Or you can sell it to some porn shop operator, and he'll take the painting and he'll make the boobs a little bigger and he'll stick it up in the window, and some other guy will come along in a raincoat, and he'll buy it.''
-Warren Buffett 
On why a business may prefer selling to Berkshire Hathaway rather than a private equity firm.

I know Warren is talking down the bidding pressure that PE firms might put on the price he has to pay for privately held businesses but looking at his comments on PE over the years it's more than that:
He actually loathes private equity and its practitioners....