Despite earlier denials.

Toys ‘R’ Us, after it filed for Chapter 11 bankruptcy last September to restructure its debts, vowed that it would go on as a company and not even close any stores. It blamed the media for having caused this problem by reporting that it had hired a bankruptcy law firm. This piece of information had, it said, caused about 40% of its suppliers to halt shipments just before the crucial holiday selling period. So it had to seek bankruptcy protection, it said. Going forward, it would try to renegotiate its debts or try to find a buyer.

But none of it worked out.

The company, at the time of it bankruptcy filing, had about 1,700 stores globally, with about 800 in the US under the Toys ‘R’ Us and Babies ‘R’ Us brands. It also had $5.2 billion in long-term debt and negative equity of $1.3 billion. In other words, what was left at the time was just a hollowed-out shell.

Today it was leaked that the company is preparing for liquidation in the US as it couldn’t find a buyer and couldn’t get the creditors to agree to take massive haircuts in a restructuring deal. It plans to close and liquidate all its operations in the US, “people familiar with the matter” told Bloomberg:

While the situation is still fluid, a shutdown of the U.S. division has become increasingly likely in recent days, said the people, who asked not to be identified because the information is private. Hopes are fading that a buyer will emerge to keep some of the business operating, or that lenders will agree on terms of a debt restructuring, the people said.

On February 21, CNBC reported that Toys ‘R’ Us was at risk of breaching a covenant on a $3.1-billion debtor-in-possession loan. A group of lenders led by J.P. Morgan Chase had extended the DIP loan to fund its operations during the bankruptcy proceedings. The covenant required that Toys ‘R’ Us keep a certain amount of cash on hand. But after bleeding cash throughout the holiday period, these cash levels were low. If the company is deemed to be in breach, the lenders could demand to be paid back the entire loan immediately, which could force Toys ‘R’ Us into liquidation.

Toys ‘R’ Us immediately came out swinging in full damage control, just like it had done in September, blaming the media. “We have not breached any covenants,” said a spokeswoman at the time. The CNBC report that it was at risk of being forced into liquidation was “full of speculation,” she said.

What’s left to liquidate? Despite its vows in September not to close any stores, it had obtained court approval earlier this year to close 182 stores in the US and shed 4,500 workers along with them. Then on February 21, the Wall Street Journal reported that the company would close 200 more stores and lay off more people, cutting its footprint in the US in half since the bankruptcy filing. But even that isn’t going to be enough.

Toys ‘R’ Us is another one of many private-equity stories that form the core of the brick-and-mortar meltdown. In 2005, during the leveraged buyout boom, PE firms Kohlberg Kravis Roberts (KKR), Vornado Realty Trust, and Bain Capital Partners acquired the shares of Toys ‘R’ Us for $6.6 billion. The firms funded the deal in large part by using Toys ‘R’ Us to borrow the money to fund its own acquisition – hence “leveraged buyout.” This operation stripped out cash and left the company buckling under its debts.

Toys ‘R’ Us is an international company with an ownership structure that allowed the overseas operations to be kept out of the US bankruptcy. But Toys ‘R’ Us in Canada filed for creditor protection at about the same time as the US filing. And on February 28, Toys ‘R’ Us in the UK collapsed into “administration” – a similar procedure where a court administrator attempts to restructure or sell the company. If this fails, liquidation of the UK entity looms, and about 3,000 jobs would be at risk in the UK.

The company is also in talks to sell its 85% state in the 400-store Asian operations to the Fung Group in Hong Kong which already owns the remaining 15%.

Retailers are notoriously hard to restructure because they have few unencumbered assets and way too much debt by the time they collapse. If they once owned their own stores, they sold them to raise money and leased them back from the new landlord, or they mortgaged them to the hilt and in case of a default, the lender takes possession of them. Shareholders usually lose everything. Many junior creditors get wiped out or nearly wiped out, and suppliers can be strung out too. But given the nature of DIP loans, it’s unlikely that the banks would feel the pain on the $3.1 billion they lent to Toys ‘R’ Us. And this is the beginning of the final and messy chapter of another failed retailer LBO.

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