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Trouble in toy town: it's time to grow up for Toys R Us and Lego

Ashley Armstrong
Toys R US filed for Chapter 11 bankruptcy protection last week after struggling with $5bn of debt that left it unable to invest in its stores or online - Getty Images North America

Bankruptcy filings don’t usually start with a theme tune. But the submission from Toys R Us to a Virginia court begins with an upbeat jingle: “I don’t wanna grow up, I’m a Toys R Us kid.” The line is the opener from the retailer’s long-running US commercials and was swiftly followed by its unusual mission statement: the chain delivers “children their biggest smiles of the year” and gives parents “an opportunity to fulfil their children’s wildest dreams”.

Since 1948 Toys R Us has been tugging on heartstrings by appealing to parents’ guilt-ridden fears that the only way their child can be happy is if they buy that latest doll, bike or playset. It has been a multibillion dollar masterclass in emotional manipulation.

However, the warm and fuzzy childhood feelings that Toys R Us has generated for the past 69 years were replaced last week with grown-up anxiety as its US operations tumbled into bankruptcy protection.

The retail behemoth had drowned under the weight of $5bn of debt. The hangover from a debt-fuelled private equity takeover in 2005 had left the chain lurching from one refinancing to the next – a move that boss David Brandon called “short-term Band-Aids”.

Toy Story characters infront of Toys R US's old Times Square store

While its bankruptcy filing included florid lines about children’s “gleeful smiles and bouncing feet”, the details painted a much grimmer picture about life behind the curtain of the world’s biggest toy retailer.

The debt pile that had been engineered by buy-out firms KKR, Bain Capital and real estate firm Vornado had left Toys R Us with an interest bill of around $400m a year, which had drastically impaired its ability to invest in the business.

As a result, the toy giant, which was once a “category killer”, has fallen behind its rivals. Its stores have been in desperate need of modernisation, the chain has been woefully unprepared for the rampant rise of online shopping, and it has failed to meet a growing demand for subscription services for baby items, which the supermarkets and other rivals now deliver.

Tom Hanks playing the big keyboard in FAO Schwarz in 'Big'

There were signs two years ago that all was not well at Toys R Us when the retailer took two brutal, financially-driven decisions to shut the larger-than-life New York store that drew in crowds of children. In 2015, six years after buying 155-year-old toy store FAO Schwarz, the company closed down the Fifth Avenue emporium, made famous for the giant keyboard featured in Big in which Tom Hanks uses his feet to bang out Chopsticks and Heart and Soul.

Just five months later, and days after Christmas, Toys R Us shuttered its vast Times Square store, which had for years attracted customers with an indoor Ferris wheel and gigantic 20-ft T-Rex statue, after rental costs soared to $42m on the site. Toys R Us still had 1,600 stores after the closures, but few of them had the same “wow” factor and were in urgent need of refurbishment.

“You have to be particularly inept to make a toy store boring, but Toys R Us managed it,” comments Neil Saunders at GlobalData. “Their shops have very little ‘pester-power’ because very few children demand to be dragged around aisles and aisles of shelves of products. The shops are no longer exciting for children, and for parents it’s more convenient for them to buy toys along with their groceries at Walmart or online.”

You have to be particularly inept to make a toy store boring, but Toys R Us managed it

Neil Saunders at GlobalData

The company, which was originally started by Charles Lazarus, who returned home after serving in the Second World War and noticed a rising demand for cots as the baby boom took hold, lost its entrepreneurial spirit a long time ago, leaving it short of the agility and financial firepower required to stay at the forefront of a changing market.

The rapid growth of online sales has put significant pressure on Toys R Us, with Amazon last year making double the amount in sales of toys and baby products in the US.

“Toys R Us once disrupted the high street with giant out-of-town stores,” said Dan Butters, partner at Deloitte. “But now the great disrupter has been disrupted, providing more evidence of the power of Amazon over traditional retailers. Coupled with the impact of being so highly leveraged and the necessity to refinance the mountain of debt it has buckled under.”

Toys R Us

In the 12 years since the company’s private equity takeover the value of online retailing has soared from $2.7bn to $12bn. Meanwhile, Toys R Us’s sales have flatlined as it has failed to invest in its website or online delivery services. And as internet sales have grown, the company’s vast store estate has become less profitable as shoppers switch bricks for clicks.

Toys R Us has also had to face the rapid changes in toy retailing, which now sees children increasingly trade-in their teddies, Scalextric and dolls for iPads and other electronic devices. Around 40pc of children now own their own electronic tablets. And while the fashion market might be notoriously fickle, it is nothing in comparison to the world of toys where children’s short attention spans have been accelerated by the internet.

Children are rapidly switching their traditional toys for electronic devices, like tablet computers

“In the first half of 2017, we saw the impact of social media in causing viral toys successes. While in years past it would have taken something like fidget spinners months to travel internationally, today, social media outlets are allowing consumers around the world to discover new toys at the same time,” comments Frederique Tutt, a toy analyst at NPD Group.

The challenges have even prompted Lego to slash 1,400 jobs after recently suffering its first drop in sales in more than a decade. The Danish toy giant, which escaped bankruptcy 15 years ago and has since enjoyed a dramatic turnaround on the back of a push into technical products and Lego films, is now “pressing the reset button” in a radical effort to address declining sales.

A Lego employee performing quality control checks

Reports surfaced at the start of this month that Toys R Us was on rocky ground, which started a “dangerous game of dominoes”, according to boss Brandon. Within a week, nearly 40pc of its suppliers refused to ship products to the retailer without cash on delivery or tighter payment terms. The company would have needed $1bn in cash to meet those demands. The timing could not have been worse for the retailer as it almost quadruples its orders to ensure there are no empty shelves in the peak holiday season, when it generates 40pc of its annual sales.

One of the saving graces for the business is that it has secured a whopping $3.7bn “debtor in position” facility to guarantee suppliers they will be paid in full for their stock in the run-up to Christmas.

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“The benefit for Toys R Us filing before the holiday is it draws a distinct line between what they owed before and the administrative claims now, so toy manufacturers know they will be paid 100pc of what they are owed and continue to supply them,” explains Ted Gavin, managing partner at Gavin Solmonese, a consultancy firm.

Gavin expects Toys R Us’s Chapter 11 to last “for around a year, but no more than two” and believes that a debt-for-equity swap will be the most likely route for the company to address its groaning debt pile. “Sorting out and reducing the $5bn of debt will be the linchpin of any exit because disposing of that liability needs to happen. I don’t think anyone is terribly concerned that Toys R Us will disappear forever. Once it’s exited Chapter 11 it could even return to the public markets,” Gavin adds.

Toys R Us will be partly saved from the scrap-heap because of its importance to the toy giants. The retailer accounted for 11pc of Barbie maker sales last year, 9pc of Play-Doh maker Hasbro and 9.4pc of action figure business Jakks, according to Wells Fargo analyst Timothy Conder.

Mattel has called Toys R Us “one of our most important retail partners”. Meanwhile, Ben Gadbois, global president of Spin Master, maker of Etcha Sketch, Hatchimals and Paw Patrol, told The Sunday Telegraph it would “continue to support Toys R Us as they restructure their business.” “Toys R Us is an important part of the toy industry and we wish them the best”, said Gadbois.

MGA Entertainment makes the popular Bratz dolls

Isaac Larian, the boss of Bratz dolls maker MGA Entertainment, is also supportive: “We believe their presence as a toy destination is important and their voice as a champion of play is needed in this industry. They currently have a number of MGA products in their stores, and we plan to continue our long-standing relationship with Toys R Us,” he said.

With just three months to go until Christmas, the toy giants will be wanting to ensure that the doors to Toys R Us remain open wide.

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