Risks and Merits of the Transaction
As for the risks, the toy retail industry is currently in decline. Stowell and Raino (2007) note that industry sales declined 4% last year and analysts’ forecasts for future sales in the US are disappointing. Moreover, toy retail is a competitive industry with such giants as Walmart, Target, GameStop, and Best Buy, which can undermine the position of Toys “R” Us. Furthermore, the nature of the transaction is no less significant risk.
Since it is a club deal, it involves the control of several investment companies. Thus, each investor will have restrictions related to the activities and aspirations of the other partners. Nevertheless, some advantages of this transaction are obvious also. Toys “R” Us has a significant cash flow, which eliminates the possibility of not paying debts when they fall due. The European toy retail market is on the rise, providing ample room for expansion.
Industry Dynamics
In 2005, the toy industry experienced a downturn due to video games and electronics development. Moreover, the policy of competitors, including Walmart and Target, to provide customers with high discounts also puts pressure on Toys. An equally crucial aspect was the ability to recognize and follow trends and demand for products, on which the firm’s success depended. Nevertheless, one segment of the industry experienced a boom. It was a market for goods for toddlers, infants, and preschoolers. There was an increase in the birth rate and an increase in the cost of babies.
Stowell and Raino (2007) state that experts predicted 3-6 % sales growth in this segment. In turn, in Europe, the situation was different. In contrast to the US, which saw a 4% decline in toy demand, European toy sales grew by 3% in 2005 (Stowell & Raino, 2007). Thus, according to analysts’ forecasts, the European pace of sales of toys should have surpassed the American ones.
Questions to Ask Toys “R” Us
- What are the company’s stable competitive advantages?
- What is the purpose of the company’s growth strategy?
- How significant is the company’s position in the industry’s value chain?
- What are the main macroeconomic factors of business?
- How many clients and suppliers do you have?
- What are the company’s key performance indicators?
Each Debt Type in the Transaction
According to Stowell and Raino (2007), prior to the acquisition, Toys had a 35% debt-financed capitalization. In turn, after the acquisition, Toys had $6.7 billion, of which $2.3 billion was existing debt and $4.4 billion was new debt. Thus, the debt of Toys amounted to 83.7% (compared to 35% before the acquisition). The deal made toys much more leveraged.
Sources of debt (in millions):
- Existing Debt: $2,312.
- Senior Secured Loan: $700.
- Unsecured Bridge Loan: $1,900.
- Mortgages: $800.
- Secured European Bridge Loan $1,000.
- Total $6,712.
Potential Exit Strategies
Three potential exit strategies for this investment can be defined. First, since currently, the company is not public, it may take part in an IPO, The second exit strategy is to take over the company with a strategic competitor, such as Walmart or Target. The third exit alternative could be selling the company to another financial investor.
Recommendation to Join the Consortium
I recommend joining the consortium on this deal since there are a number of positive reasons for this. First, because Toys “R” Us has experienced industry difficulties and poor performance, the purchase comes at a huge premium of 122.5% (Stowell & Raino, 2007). Second, the firms participating in this LBO enter into a potentially lucrative club deal. Bain Capital has essential resources to realize and analyze the boom and bust characteristics of the industry. KKR is well established in the private equity industry, and Vornado can assist in valuing and managing Toys’ huge real estate. Thirdly, there is a lot of room for growth in this industry through online sales, sales to children and toddlers, and sales in Europe.
Reference
Stowell, D.P., & Raino, M. (2007). The Toys “R” Us LBO. Kellogg School of Management. Web.