Toys R Us News Cheers Some, Baffles Others

'They're throwing in the diaper,' says one wag.
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Updated from 9:39 a.m. EDT

Analysts had a mixed reaction to news Wednesday that besieged toy retailer

Toys R Us

(TOY)

will hive off its Babies R Us unit and restructure its global toy operations in an effort possibly to sell them.

The Wayne, N.J., chain, which has been struggling with waning sales in the increasingly competitive toy sector, hopes to reduce operating expenses in its corporate headquarters and U.S. toy business by more than $125 million in 2005, compared with 2003. It also wants to cut capital spending in the global toy business to less than half its annual depreciation and amortization expense, which stands at about $300 million.

The company will take about $150 million in second-quarter markdowns to liquidate toy store inventory and about $14 million in severance charges in the quarter related to the restructuring of its headquarters.

"It looks as if Toys R Us management reviewed results during June and July and are throwing in the diaper," said Richard Hastings, retail sector analyst at Bernard Sands. "The news release is somewhat confusing -- it sounds like the entire enterprise is up for grabs.

"There are certainly some ominous warnings in here: the markdowns, the severance payments, and the huge cut in spending all represent typical late-phase issues."

Shares of the company were lately down 35 cents, or 2.1%, at $16.07.

Another analyst called the news a huge positive for investors. "One of the critical pieces to unlocking shareholder value in Toys R Us is separating its crown jewel, Babies R Us," said Prudential Equity analyst Mark Rowen in a research note.

The company's strategic review was designed in part to address its waning core U.S. toy business. The company has not said when the review will be completed but said in March that it is taking longer than it thought to finish. Toys R Us' waning sales have been a byproduct of discounter

Wal-Mart's

(WMT) - Get Report

aggressive toy pricing. The company said in March that the upcoming 2004 holiday season will be a critical time for it to maintain its competitive edge.

Toys R Us said its board approved operating the two businesses as separate entities within the existing Toys R Us corporate structure and hopes to have the separation done by the first half of 2005. It added that it would not be appropriate to make a decision on the Babies R Us unit until after the holiday season, which could be the ultimate make-or-break quarter for the company.

"The series of steps we are announcing today reflect the fact that our global toy business and our Babies R Us business operate in distinct markets, and are at fundamentally different phases in their growth cycle," the company said in a press release. "Consequently, by ultimately operating them as separate entities, we will provide a better opportunity for Babies R Us to continue its healthy growth."

Said Hastings: "The inability of Toys R Us to expand and follow the masses now leaves them in that very complex, late-phase set of limited alternatives, and the timing is not necessarily optimal. Consumer spending is weakening, and retail real estate is at high capacity."

Rowen said the real estate value of the Babies R Us stores is a "critical piece of the valuation puzzle," which he thinks the company will address at a later date.

He also said the stock's decline presents a buying opportunity. "Our sum-of-parts analysis suggests total net asset value at Toys R Us to be $27 per share. Assuming a value of $11 per share on Babies, yesterday's closing price of $16.42 means that market is currently valuing the remaining assets at $5.42 a share."

Toys R Us moved its second-quarter earnings announcement back to Aug. 23 from its previously scheduled Aug. 16. The company expected to post a loss of 3 cents a share, according to Thomson First Call, which would compare with a loss of 5 cents a share in the second quarter last year.

It also said Richard Markee, founder of Babies R Us and currently a vice chairman of Toys R Us, was appointed president of Babies R Us and will become chief executive and president of Babies R Us on separation. Jon Kimmins, currently treasurer of Toys R Us, will become CFO of Babies R Us at separation.

Meanwhile, the company is on "credit watch" at Standard & Poor's. In its most recent quarter, the company said its U.S. toy division saw same-store sales fall 5.6% from a year ago, including a 27% decline in video-game sales. It had reported a quarterly loss of 13 cents a share.