Toys ‘R’ Us: Could the buildup blow up?

Toy store's pre-IPO expansion strategy is puzzling

By InvestorPlace Aug 24, 2011 6:25PM

By Tom Taulli,


Since its start in 1948, Toys “R” Us has always found ways to evolve and grow. But its luck might be running out as the retail landscape is undergoing cosmic shifts. In other words, can an operator like Toys “R” Us survive the onslaught from rivals like Wal-Mart (NYSE:WMT) and Amazon (NASDAQ:AMZN)? And will the stagnant U.S. economy make things even worse?


OK, it’s unlikely that Toys “R” Us will become obsolete. This seems a bit extreme. But it’s likely the problems will grow and grow.


But Toys “R” Us doesn’t look worried. For example, the company has announced plans to launch 21 stores this year, which will include 11 “R” superstores. They will be roughly 60,000 square feet and will meld the Toys “R” Us and Babies “R” Us formats.


Huh? That’s right. It really does sound like out-of-touch thinking at work. Consider that five of the locations will be in California, which has a horrendous 12% unemployment rate.


Then again, I’m sure some MBAs have supporting spreadsheets to make things work. Isn’t it interesting how these kinds of projections always look clean and compelling?


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Oh, Toys “R” Us also will launch 10 “side-by-side store” locations. Also, 23 renovated stores will be turned into this format as well.


Sound kind of confusing? It sure does. But so did the actions of companies like Borders and Blockbuster. It’s amazing what companies will do when they are under tough market pressures.


Even more eerie is the press release on the expansion plans. In it, the CEO of Toys “R” Us, Gerald Storch, talks about an “enhanced shopping experience,” “differentiated toys” and “exceptional convenience.” Yes, it’s typical corporate-speak. Then again, he was a former partner at McKinsey & Co and has an MBA — and a JD — from Harvard. No doubt, he’s a whiz at Excel.


Now, Toys “R” Us does have compelling assets. Perhaps the most important one is the brand, which is recognized throughout the world. The Toys “R” Us has brand awareness with 98% of those who are older than 18. That’s serious stuff.


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The web business also is attractive. Over the years, Toys “R” Us has been smart to buy up operators like, and In 2010, online sales reached $782 million.


Finally, Toys “R” Us has extensive relationships with vendors. As a result, the company has a great product assortment and also benefits from economies of scale. These definitely are key barriers to entry.


Yet the fact is Toys “R” Us still looks like an anachronism. After all, the future of specialty retailing is looking a bit dubious. The problems might actually accelerate because the U.S. economy seems to be in a long-term funk. Besides, how much growth can there be with Toys “R” Us when it already has 1,396 stores?


So why the expansion? It’s probably a way to pump things up as Toys “R” Us tries to get its IPO off the ground. The private equity owners — Bain Capital Partners LLC, Kohlberg Kravis Roberts & Co. (NYSE:KKR) and Vornado Realty Trust (NYSE:VNO) — took the company private in July 2005 at a whopping $6.6 billion. It was near the top of the buyout bubble.


Since then, these PE firms have been engaging in financial engineering. But such things usually have short-term potential.


Take the recent case of HCA (NYSE:HCA). Since coming public in March, the shares have plunged from $35.37 to $19.48. Ouch!


But of course, the IPO market is even worse now in light of the recent plunge. Thus, the interest for a Toys “R” Us offering does look questionable.


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However, even if the company does somehow get the deal off the ground, investors really

need to be cautious. True, there might be a pop on the stock price. But the long-term problems of retailing will remain, and the results could prove quite painful for investors.


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