The Curmudgeon remembers the first time he set foot in a Toys R Us store. It was in early December of 1995, nine months after his nephew was born, and it was a nice day so he walked to the store in search of Chanukah presents for a child he knew would certainly not appreciate them because nine-month-olds don’t appreciate very much. The store itself was pretty daunting: aisle after aisle of toys and games and gadgets, but The Curmudgeon, then 38 years old, forged ahead, found what he was looking for, and made a mental note to return after the first of the year to pick up two things he wanted for himself: an Etch A Sketch and a four foot tall crayon piggy bank that he still has.
Recently we learned that Toys R Us is going out of business. The experts cite a number of reasons for the company’s demise: competition from real stores like Walmart and Target and Costco and virtual stores like Amazon; outdated stores; a lousy web site; and more. Published reports also cite the company’s debt as one of the reasons it failed, but usually, they don’t mention the source of that debt – and they should. It’s not that Toys R Us wasn’t still selling an awful lot of toys and doing so profitably, because it was. No, the problem was with the companies that owned Toys R Us: they intentionally racked up debts so huge and spent so lavishly that the company never really had a chance.
In 2003, three large venture capital companies purchased Toys R Us through what’s known as a leveraged buy-out. On paper, they paid a lot of money for the company: $6.6 billion. Of that amount, however, they only came up with about 20 percent themselves. For the rest, they borrowed against the assets of the company – assets like real estate, buildings, and inventory – but only after they took possession of the company.
But while on the surface “they” borrowed the money against the company’s assets, the venture capital companies themselves didn’t borrow any money at all: they arranged it so that Toys R Us, not them, borrowed the money, leaving Toys R Us on the hook for more than $5 billion. This meant that before they ever sold even a single Etch-a-Sketch after hanging the “under new management” banner, the company owed creditors $5 billion.
That’s the “leverage” part of a leveraged buy-out: the buyers use the leverage of the company and its assets and don’t put their own money at risk. They know the business is at least viable enough to let them drain it of more money in the form of huge management and advisory fees they charge to help run the company into the ground, and after they’ve gotten a suitable return on their investment they don’t give a damn what happens to it.
Toy R Us never really had a chance, especially after the massive management fees the new owners extracted from the company – fees they took ahead of paying down the debt. The company they bought had $2.2 billion in cash and assets on hand, but by 2017 only $300 million of it was left – and it still owed $5.2 billion, which was roughly the amount of debt the venture capitalists forced on the company in the first place. In addition, the company was paying between $400 million and $500 million a year in interest alone on its debt, which was far, far more than Toys R Us was losing even in its worst years. In other words, the debt made the difference between the company making money and the company losing money. The new owners, though, weren’t losing money: they were raking it in hand over fist.
In the end, it didn’t really matter that the stores were outdated, the competition was tough, and the web site was weak. After saddling the company with a level of debt it could never repay, the new owners milked Toys R Us for all it was worth, and then, when the milk dried up, they announced that they would close the doors, stiff the people from whom they borrowed those billions of dollars, and fire 33,000 employees.
Isn’t the American way of doing business just swell?