BUSINESS
Who Killed Toys ‘R’ Us? Hint: It Wasn’t
Only Amazon
A small group of hedge funds decided the iconic retailer was worth more dead than alive, a
sign of debtholders’ increasing power in bankruptcy court
When Toys “R” Us sought bankruptcy protection last September, there was good
reason to believe the iconic retailer would work through its problems and emerge a
leaner but viable company. Its suppliers were confident enough they continued to fill
its shelves with toys.
On March 15, however, to the surprise of most people involved, the 70-year-old
company announced it was shutting for good. Some 33,000 workers lost their jobs.
Vendors now face at least $350 million of losses. The toy maker Mattel Inc. took a big
hit to its bottom line.
Many factors contributed to the retailer’s troubles, including the costs of a leveraged
buyout, competition from Amazon.com Inc. and a disastrous Christmas season. What
pushed it over the edge, however, was a small group of hedge funds.
Solus Alternative Asset Management, a New York hedge fund, pressed four other Toys
“R” Us debtholders to conclude that the company was worth more dead than alive,
according to two Toys “R” Us directors. That was enough to halt the company’s frantic
restructuring effort.
Toys “R” Us “had real people, credible institutions, engaged in a serious discussion
around potentially reorganizing the company,” said David Kurtz, head of restructuring
Aug. 23, 2018 10:26 a.m. ET
By Gretchen Morgenson and Lillian Rizzo
at Lazard and an adviser to the company, at a March court hearing. There was a deeppocketed
investor talking to the company about backing the effort, he said.
Yet before the company could finish pulling together a reorganization plan, the five
debtholders ran out of patience. They held a critical piece of secured debt with a face
value of $668 million—a minority of the $5.3 billion of debt the company listed when it
sought chapter 11 protection, bankruptcy court records show. Under the company’s
complex capital structure, they had the power to essentially stop the clock on the
reorganization effort. Toys “R” Us concluded it had no choice but to liquidate.
Creditors have long played a key role in determining whether companies operating
under chapter 11 bankruptcy protection will live or die. The five funds in this
case—they also included Angelo, Gordon & Co., Franklin Mutual Advisers, Highland
Capital Management and Oaktree Capital —were exercising their rights as creditors
and their duties to generate returns to their investors.
The company’s stores, including this one in Queens, N.Y., held liquidation sales that drew numerous bargain hunters.
PHOTO: RICHARD B. LEVINE/NEWSCOM/ZUMA PRESS
In an Aug. 21 letter to a Toys “R” Us employee-advocacy group, lawyers for Solus
and Angelo Gordon said, “the unfortunate result for Toys “R” Us was neither our
clients’ desired result nor caused by our clients.”
Today, as the Toys “R” Us case shows, these kinds of creditors wield more influence
than ever. Since the financial crisis, the practice of layering companies with tiers of
debt has become more common, restructuring experts say, which adds to the
complexities of bankruptcy filings. As hedge funds and other investors accumulate
stakes in these tiers of debt, they can gain a so-called fulcrum or crucial position in
restructuring negotiations.
“Secured creditors have developed greater power to control the process than Congress
expected them to have when it created chapter 11, and probably more than is healthy
for a system in many cases,” says Jonathan Lipson, a Temple University professor
focused on bankruptcy. “Hedge funds have their own liquidity needs, their own
investors looking for certain kinds of returns in certain periods. It can be hard for them
to be patient with a reorganization process.”
The chapter 11 bankruptcy system is designed to provide a transparent and fair
process for resolving creditors’ claims against financially troubled companies. It sets
up a pecking order among those who are owed money, with secured bank lenders
generally sitting at the top, bondholders in the middle—secured, then unsecured—and
stockholders at the bottom.
The $5.3 billion in debt Toys “R” Us listed when it filed for bankruptcy on Sept. 19 was a
hangover from a $6.6 billion leveraged buyout in 2005 at the height of that decade’s
buyout boom. Private-equity firms Bain Capital and KKR & Co., along with Vornado
Realty Trust, led the buyout and have been taking heat for the retailer’s demise, partly
because their deal loaded up the company with debt. The rise of online competition and
the company’s outdated stores also contributed to its woes. Bain, KKR and Vornado say
they invested more than $1.3 billion in the Toys “R” Us deal and wanted the company to
stay alive, but were unwilling to put in more money.
The role played by Solus and the other funds in the company’s demise has attracted
less attention.
Distressed-debt investors typically buy debt at a discount to the original dollar value.
It couldn’t be learned how much the five funds paid for their Toys “R” Us holdings, but
court records and price data indicate that Solus bought much of its position for less
than 50 cents for each dollar of face value.
Solus, a $6.3 billion hedge-fund company founded in 2007, was among Toys “R” Us’s
smaller debtholders early on. By this June, it had become the largest holder in the debt
issue known as B4, with $221 million in face value of the $1 billion issued. That layer of
debt became pivotal to the reorganization effort because its holders had supplied
collateral for additional bankruptcy financing.
Solus contributed $31 million at the time of the bankruptcy filing for what is known as
debtor-in-possession financing, which kept the retailer operating through last
Christmas—money that, under bankruptcy law, is first in line for repayment.
A research report from HSBC says Solus also bet against Toys “R” Us debt by placing a
$25 million short position in another debt security, possibly in an effort to hedge its
debt holdings.
Hedge fund Solus Alternative Asset Management held a critical piece of Toys “R” Us debt. Its executives include,
from left, C.J. Lanktree, CEO Christopher Pucillo and Scott Martin. PHOTO: EVAN KAFKA
Solus has said that buying into troubled companies that are likely to be liquidated
generates higher and more reliable returns. “Unlike traditional distressed
opportunities, liquidations remove valuation and process risks,” the firm noted in a
2012 presentation at a hedge-fund conference, meaning its money wouldn’t be tied up
in lengthy reorganizations.
At Toys “R” Us, the decision by vendors to continue shipping merchandise after the
chapter 11 filing meant shelves were loaded with new and in-demand goods that could
be sold quickly and easily in going-out-of-business sales. That would make for a speedy
payoff for creditors.
The company’s management, directors and advisers met twice a week throughout the
bankruptcy process searching for ways to save the company, according to the two
board members.
The group considered finding a new investor or buyer, slimming down the chain to a
smaller number of stores and anchoring the North American business on its Canadian
operations. A U.S. without a Toys “R” Us presence was never under consideration, say
the two directors. All the options would have required some leeway from the B4 lender
group, the two directors say.
The company and its representatives pleaded with Solus and the other B4 debtholders
to waive a requirement that the company’s forecast maintain a certain level of cash
flows in its operations, court records show. The funds agreed to such a waiver in
January. That deal was set to expire on March 3.
Mr. Kurtz, the company’s adviser from Lazard, recalled in a later court hearing
what he told the funds. “You guys really should get on board and help us support”
the company’s effort to continue operating, he recalled saying, because that is where
the most value will be created. He said he then described “why the management team
believes that we can and will be successful.”
The company hadn’t yet put together a formal restructuring plan, which would have
laid out exactly what each class of debtholders would receive in exchange for their
defaulted debt. Yet certain conditions were clear, court documents show. Although
Solus and the other funds wouldn’t have had to put additional money into the
company, they would have had to subordinate their claims to any new investor who put
in money to help the company reorganize.
Earlier this year, some of the funds holding B4 debt alongside Solus were supportive of
the reorganization, a person familiar with the situation said. One of them was
Marathon Asset Management. Solus bought out Marathon’s stake earlier this year.
Marathon declined to comment.
In March, when the waiver was set to expire, there was still no deal in place. On March
5, the B4 debtholders told the retailer they would extend the waiver for one week on
two conditions—Toys “R” Us had to stop paying its landlords and some vendors.
The company felt that wasn’t enough time to put together a deal. Up against the wall, it
decided to liquidate.
The fund companies told the bankruptcy court they recognized a liquidation would
cause pain. Acknowledging the funds would benefit from the wind-down, their lawyers
told the court in April that a liquidation presented creditors with “a path to stability
and value preservation in a very difficult situation.”
Not all creditors saw it that way. Crayola LLC, the crayon manufacturer, was owed
roughly $2.3 million for goods shipped between December and early March, one week
before the liquidation announcement. “These Debtors have called it quits and are
liquidating solely for the benefit of their senior secured lenders,” a Crayola
representative said in court papers.
The decision to liquidate Toys “R” Us and its 800 stores has affected suppliers,
employees, even the taxing authority in Wayne, N.J., where the retailer was based.
The company’s former flagship
store in Times Square, which
included a Ferris wheel, closed
in 2015. JAMES
LEYNSE/CORBIS/GETTY
IMAGES
Former Toys ‘R’ Us Kids Say Goodbye as Final Store Closes
VIEW IN DEPTH
According to Moody’s Investors Service, the company was Wayne’s third-largest
taxpayer, contributing $2.1 million to town coffers in the 2016 fiscal year, or 2.5% of its
operating revenue.
Toy makers large and small are bracing for possible revenue declines. Toys “R” Us was
Mattel’s second-largest customer. Mattel recently reported that sales declined 14% in
the second quarter. It could lose millions on shipments made to the retailer after
January, court documents indicate, and it has announced large layoffs.
The shelves were empty at a Toys “R” Us store in Houston days before the final closing. PHOTO: GODOFREDO A.
VASQUEZ/HOUSTON CHRONICLE/ASSOCIATED PRESS
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When Circuit City Stores Inc. and Borders Group Inc. sought chapter 11 protection in
2008 and 2011, respectively, vendors still had Best Buy Co. and Barnes & Noble Inc.
After Toys “R” Us stores went dark in June, the industry had no dedicated big-box
outlets.
Vendors who kept shipping goods to Toys “R” Us hoping for a reorganization will
receive at least 22 cents on the dollar for the $800 million they are owed, according to
court papers.
The fund holding the proceeds from the Toys “R” Us liquidation allocated money to pay
employees for two additional months of work, along with $74.3 million to cover some
bills, including professional fees. All told, roughly $370 million is expected to be paid to
professionals working on the case, the records show.
Maryjane Williams, 50 years old, a mother of five, worked for Toys “R” Us for more
than 20 years in New York state, and more recently, Waco, Texas. She says she worries
that her health insurance, which expires in November, won’t cover the medical
expenses of her husband, who is recovering from an accident.
Ms. Williams is among a group of Toys “R” Us employees fighting for severance pay.
The company notified workers they would receive no pay beyond its final day of
operations. Some workers say the company had promised severance pay, then
reversed course.
The liquidation strategy appears to be paying off for Solus. Court records and market
data suggest it will receive more than it paid for its stake.
Write to Gretchen Morgenson at gretchen.morgenson@wsj.com and Lillian Rizzo at
Lillian.Rizzo@wsj.com
Appeared in the August 24, 2018, print edition as ‘Five Investors Sealed Fate of Toys ‘R’
Us

.’1. When did Toys “R” Us seek bankruptcy protection? When did it announce it was shutting for good?
2. Why do you think suppliers continued to show confidence in Toys “R” Us? Was this a mistake? Why or why not?
3. How did a leveraged buyout contribute to the firm’s bankruptcy?
4. When is a firm worth more dead than alive? When is a firm worth more alive than dead?
5. When are leveraged buyouts a good idea? When are they a bad idea?