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Toys ‘R’ Us Leveraged Like ’05 as Loss Mounts: Corporate Finance

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Last month, Toys “R” Us announced a $1 billion loss for fiscal 2013, its worst performance since at least 1987, Bloomberg data show. Photographer: Peter Foley/Bloomberg

April 14 (Bloomberg) -- Toys “R” Us’s debt ratios returned to levels last seen following its $6.6 billion leveraged buyout in 2005, underscoring heightened concern among investors that the retailer may not be able to recover from its biggest loss in nearly three decades.

“It’s always there, you never get away from it,” Sean McGowan, an equity analyst who focuses on the toy industry at Needham & Co. in New York, said about the company’s debt load. “Something’s got to change, that’s for sure.”

Debt at the Wayne, New Jersey-based company has climbed to more than 8 times its cash flow, the same as when it was bought nine years ago by KKR & Co., Bain Capital LLC and Vornado Realty Trust, according to Moody’s Investors Service. The ratio is up from 5.3 times a year ago and compares with an industry average of about 3, according to data compiled by Bloomberg.

A candidate for an initial public offering as recently as 2010, the toy seller is now struggling to reverse a billion-dollar loss last year in an environment where three specialty retailers have sought bankruptcy protection since December amid sluggish consumer spending. More than $850 million of its bonds trade at distressed levels, and Moody’s cut the company’s credit rating this month to six levels below investment grade.

“We made significant progress on important refinancings,” Kathleen Waugh, a spokeswoman, for Toys “R” Us wrote in an e-mail. “The company has a successful track record of refinancing and, at this time, has no material outstanding debt repayments due until 2016, providing a large window to grow and develop new strategic initiatives.”

Bonds Plunge

The retailer’s $450 million of 10.375 percent bonds due in August 2017, traded at 81 cents on the dollar April 11, down from 110.5 cents in May, according to Trace, the bond-price reporting service of the Financial Industry Regulatory Authority. They yielded 17.5 percentage points more than similar-maturity Treasuries.

Those debentures along with $400 million of 7.375 percent notes due October 2018 are among the 154 securities considered distressed, Bloomberg data show. The measure tracks bonds that yield at least 10 percentage points more than comparable government debt.

Last month, Toys “R” Us announced a $1 billion loss for fiscal 2013, its worst performance since at least 1987, Bloomberg data show. Sales at stores open at least a year fell 5 percent at U.S. locations and dropped 3.3 percent internationally.

“They were out of stock, and that may be related to managing cash too tightly, but it’s inexcusable for Toys ‘‘R’’ Us to be out of stock,” McGowan said.

Retail Competition

The retailer competes with giants such as Wal-Mart Stores Inc. and Target Corp. that attract a steady stream of customers with groceries and other basics.

And the one area where Toys “R” Us had distinguished itself in the past -- the breadth of selection -- is now challenged by Amazon.com Inc., McGowan said.

“What Wal-Mart, Target and Amazon can do is they can use toys to drive traffic to stores or online, and if not toys then they can sell other stuff,” Charles O’Shea, an analyst at Moody’s, said in a telephone interview.

On April 4, Moody’s cut the company’s corporate family rating one level to B3, six levels below investment grade. Standard & Poor’s has an equivalent B- rating on the debt. Moody’s analysts cited the toy seller’s inability to capitalize on its video business, an area that has been beneficial to competitors.

Leverage Surges

Toys “R” Us leverage, after having improved in the last few years, is back to post-buyout conditions after “one bad year,” he said. “It just shows how fragile the company’s credit metrics turned out to be given the highly leveraged capital structure.”

Toys “R” Us’s total debt of $5 billion compares with adjusted earnings before interest, taxes, depreciation and amortization of $588 million for the year ended Feb. 1, according to a March 31 regulatory filing.

The average leverage, or the ratio of debt to Ebitda for publicly traded U.S. consumer discretionary companies with at least $500 million in obligations is 3 times, Bloomberg data show.

Shelved IPO

The company’s owners had looked to the equity markets to help it cut debt, filing for an $800 million initial public offering in May 2010. It shelved the plan almost three years later, citing poor market conditions and a pending leadership change.

Toys “R” Us named Antonio Urcelay, who served as interim chief executive officer after leading the European division, as permanent head in October. At the same time, it announced Hank Mullany, a former executive at Wal-Mart, as president of its U.S. business.

The company competes for a share of the global toy market, which has been flat at about $84 billion over the past four years, according to a Jan. 28 Fitch Ratings report. Traditional product categories have faced increasing headwinds with children expressing a preference for digital games, the report said.

Debt Maturities

It faces more than $1 billion of debt coming due in 2016 even as capital expenditures will exceed cash from operating activities by as much as $250 million over the next two years, Fitch analyst Isabel Hu said.

Coldwater Creek Inc., a women’s clothing retailer, filed for bankruptcy protection last week, following Dots LLC and Loehmann’s Inc., as consumer spending remains shaky.

“There is increasing business risk as well as liquidity pressure,” Hu said in a telephone interview.

While reviving an IPO might be a best-case option in two or three years, the key for the moment is to stabilize operations and then try to push out debt maturities, Steven Azarbad, co-founder of Maglan Capital LP, a New York-based hedge fund specializing in distressed securities, said in a telephone interview.

“I think everyone is just really looking at this right now as a show-me story,” Azarbad said. The owners “definitely want to buy themselves more time. Clearly a near-term exit on this investment is not in the offing.”

To contact the reporters on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net; Lauren Coleman-Lochner in New York at llochner@bloomberg.net

To contact the editors responsible for this story: Faris Khan at fkhan33@bloomberg.net

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