Property Casualty

Toys 'R' Us Shows Real Estate Can't Save Retailers

Property has extended declines, but it's no longer a lifeline.
Photographer: John Marshall Mantel/Bloomberg

There's a common belief that retailers that own real estate are in a better position than those that don't.

This makes sense from a theoretical perspective. Property holds value that's independent of a specific brand and is less prone to the notoriously fickle world of clothing and accessory trends.

But Toys "R" Us, which just filed for bankruptcy despite owning a significant amount of land, proves that the reality can be quite different. It has relied on its land to serve as collateral for an unwise amount of debt. The company has sought to prop up its failing business model for years by shuffling debt around and adding leverage to less-encumbered assets. This has undermined the extra safety and value that the real estate should have provided. 

As analysts dug through the various slices of Toys "R" Us debt ahead of the company's bankruptcy filing on Monday, one thing has become abundantly clear: It has an incredibly complicated capital structure. It has an operating company subsidiary, which is thought to pay above-market rates to lease land from a property company subsidiary. The property company has sold debt. So has the operating unit. So has the parent company, which has pledged its real estate to back other debt separate from the property unit under certain circumstances.

None of these arrangements or the current worth of the property have been spelled out clearly by the company in recent months. It's likely that the land is worth considerably less than estimates from even last year because the company will need to close stores, can't afford to pay expensive leases, and retail spaces in general are under pressure. As Bloomberg Intelligence's Noel Hebert pointed out, these leases will quite possibly be renegotiated in any reorganization.

Toys "R" Us is grappling with about $5 billion of debt, mostly left over from the $7.5 billion buyout by private equity firms including Bain Capital, KKR & Co. and Vornado Realty Trust more than a decade ago. It has evidently run out of time to prove that it has a viable plan for meeting its near-term debt payments, which include $3.5 billion coming due through 2020 and $450 million that matures next year. Its suppliers reportedly scaled back shipments in recent weeks amid concerns about the retailer's future, which is terrible timing because the fourth quarter is the busiest period for toy stores. Meanwhile, its Ebitda is expected to decline this year, according to Fitch Ratings. It hasn't been able to invest in beefing up its website or physical stores and faces stiff competition from Amazon.com. Its baby business is a bust.

Cliff Diving

Toys "R" Us bonds plunged in response to the company's preparation to file for bankruptcy

Source: Bloomberg, Finra's Trace bond-price reporting system

 Not only that, but a previous distressed-debt exchange that the company did less than two years ago was unsuccessful at shoring up its finances. 

Little Improvement

Toys "R" Us bonds that were renegotiated less than two years ago are also falling

Source: Bloomberg, Finra's Trace bond-price reporting system

There are many lessons to be learned here. One big one is that land-owning store operators don't necessarily have such an advantage over their property-less brethren. That's because companies such as Sears Holdings Corp. and J.C. Penney Co. Inc. have stretched out their long decline by using their real estate to help prop them up without necessarily making fundamental changes that give them a better chance for survival down the road. As Toys "R" Us is proving, delaying the inevitable doesn't mean that an unpleasant end won't come, or that it won't still be painful. 

Once upon a time, some extra land might have helped shore up brands that were struggling in the face of Amazon.com and changing trends. But now, it's much less certain how much of a support this real estate really is.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lisa Abramowicz in New York at labramowicz@bloomberg.net

    To contact the editor responsible for this story:
    Daniel Niemi at dniemi1@bloomberg.net

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