Toys 'R' Us Has Time To Craft Turnaround, Despite Troubles

NEW YORK (The Deal) -- Toys 'R' Us just may have gotten the liquidity it needs to make next Christmas, and a few ones after that, a happy one for tots - as it reduces debt and revamps its operating procedures.

Although the Wayne, N.J.-based toy retailer is not imminently facing a potential bankruptcy filing, it still has a way to go until its private equity backers can expect to seek an exit.

That's because, with the company refinancing its $1.85 billion senior secured revolving credit facility and pushing out maturities until 2016, industry sources said it has at least a year or two to craft its turnaround.

But it will also mean that private equity firms Bain Capital LLC and Kohlberg Kravis Roberts & Co. LP, as well as Vornado Realty Trust, which took the company private in 2005 for $6.6 billion, will have to wait a bit longer to make their exit.

The backers were hoping to exit the retailer around this time, an industry source said, but plans for an initial public offering were pushed back at least another couple of years by dismal earnings figures. It already filed for an IPO in 2010 but then withdrew it a year ago.

For the year ended Feb. 1, Toys 'R' Us generated about $12.5 billion in net sales, compared to about $13.5 billion for the same period a year prior, according to the company's earnings report released Monday, while the company's profits plummeted to a net loss of about $1 billion from net earnings of nearly $40 million for the same period a year earlier. Ebitda dropped for the fiscal year to $35 million from about $960 million the year prior, while adjusted Ebitda, according to the company, was nearly $600 million, down from about $1 billion.

Besides the credit facility, which the company announced it refinanced on March 26, Toys 'R' Us had $644 million in cash and cash equivalents as of Feb. 1, according to Monday's earnings statement.

At the same time, the company said last week it had reduced total long-term debt by about $320 million, to $5 billion.

Toys 'R' Us also has valuable real estate it has yet to monetize, one source said.

One person familiar with the company noted that its bonds were trading as though it had nearly a 75% chance of defaulting over the next five years.

"It is trading with a lot of hair on it," the source said, meaning it is complicated bet.

To buy a credit default swap for $10 million worth of bonds over 5 years would, currently cost 30 points up front, or $3 million, and then 500 basis points per year, or 5%, the source said. Spreads on the company's 5-year CDS have widened from about 1300 to nearly 1600, or more than 20% since March 25, according to Bloomberg data.

Prior to its refinancing efforts, analysts viewed the retailer's capital structure as not being viable, according to at least one Bloomberg report.

But the source said that the company has plenty of cash on its balance sheet to make debt payments, and it is not in danger of tripping any covenants.

For one thing, a bond analyst said, Toys 'R' Us does not have any maintenance covenants on its debt, which means that it does not have to maintain certain levels of profitability or cash on its balance sheet, something that might make it more likely get into trouble with its lenders.

The source said the problem for Toys 'R' Us is not necessarily worry over a near-term bankruptcy filing.

Rather, the market wants to see evidence that the ailing retailer can be turned around, because, similar to electronics retailers, the category is highly vulnerable to e-commerce.

But its new two-to-three-year window to turn itself around, is just that, sources said. If the company can't figure out how to compete with the likes of (AMZN), it might have to resort to bankruptcy protection.

Toys 'R' Us said it plans to bolster its e-commerce efforts and use its leverage with toy companies to offer exclusive products, among other initiatives, to improve the company's fortunes, although it does not plan on many store closures.

"Our global network of stores generates strong profitability, and together with our $1.2 billion global e-commerce business, is integral to our growing omnichannel capabilities. And, as the world's leading dedicated toy and juvenile products retailer, we have well-established relationships with our manufacturing partners, and can provide them with a year-round distribution outlet that showcases the broadest selection of their products in 36 countries around the world," Antonio Urcelay, chief executive of Toys 'R' Us, said in a March 26 statement.

He blamed the toy retailer's recent misfortunes on "execution issues," rather than macro trends such as a decline in birth rates or the competitiveness of online retailers.

Toys 'R' Us will focus on improving the in-store and online shopping experience, and will use loyalty programs and targeted marketing to get consumers in the door, said Hank Mullany, the company's president, in a statement.

Cleaning up stores, shortening wait times for checkout, having more inventory of out-of-stock items and improving customer service were some of the areas the company said it would focus on this year. To cut costs, the company may also further reduce headcount, after eliminating more than 500 positions, it said.

Toys 'R' Us has also decided to close the McCarran Distribution Center in Storey County, Nev., on June 1, 2014. The toy retailer, however, will continue to expand in places such as China, opening stores and distribution centers, it said.

The company and its backers did not immediately respond to a request for comment.

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