The purchase of Toys ‘R’ Us by a combination of two private equity firms and a big realty trust has lead to speculation on what the future of the unit might be. The best speculation has to begin with identifying exactly who the buyers are.
Vornado Realty is obviously interested in the real estate sitting under the 150 to 200 money-losing and marginal stores which TRU is likely to close in order to boost profitability. Most of these locations will likely be leased at high prices to fast-growing retailers like Lowe’s, Bed Bath & Beyond, Linens ‘n Things, etc. In addition, realty trusts (REIT’s) must pay almost all of their earnings out to shareholders in order to qualify for their tax-free status. This means that it is difficult for them to use retained earnings in order to purchase new properties. Some of the TRU stores that are in very bad locations, and there are many, will likely be sold outright to fuel Vornado’s war chest.
Private equity firms generally like to get their money out in a four to six year time frame. As a growth vehicle, Babies ‘R’ Us will likely be taken public in three or four years at a high multiple to earnings. Keep in mind that infant supplies are a high traffic driver and no one likes to drive traffic like Walmart. They could decide to seriously enter the baby business at any time and a repeat of TRU’s toy business saga could easily follow. The envisioned Babies ‘R’ Us offering to investors is likely to be a big windfall for KKR and Bain Capital, but a big mistake for investors.
Before discussing the toy division, it is time to give credit where credit is due. Here at Toyjobs Monthly, we have frequently lambasted The Dude for his ineffectual management of TRU’s business. While we still feel that this has been the case, he should be applauded for getting top dollar for TRU shareholders (including himself of course). His legacy is likely to be that he was more successful at selling the company than he was at selling toys. It is now time for him to ride into the sunset with saddlebags full and leave the business of management in more capable hands.
We are hoping that those hands will continue to be those of John Barbour. John has been successful at every job he’s ever had. Of those, this will be the toughest. Mr. Barbour has voiced a desire to see a return to innovation in the toy business. He also has spent most of his career on the manufacturer’s side of the table and it is hoped that he will partner with, rather than pound, on his vendors.
Under private equity ownership, success is likely to be measured differently. Walmart and Target are not going away. But a leaner TRU, after shedding its weaker stores and with a sound retail strategy, should be able to become a cash cow. As a public company, success was all about growth and growth is difficult in a mature business. Under private equity ownership, the spinning off of large amounts of cash would be a very good thing indeed. After the cash machine is streamlined in five or six years it could be either sold off to a major (foreign?) retailer (not likely) or another private equity group (more likely) or even kept (less likely). In any case, we envision current ownership and hopefully management being in place for five or six years.
In other major retail news, Walmart critics are having a field day. Did Tom Coughlin simply steal $500,000 from Big W or, as he claims, was the money used in a secret anti-union slush fund reminiscent of the Nixon era? My take is that this is not necessarily an either/or situation and that it is quite possible that both are true. We note with interest that Walmart froze approximately 30 million worth of Coughlin’s retirement benefits but only after he publicly stated that his defense would be that the bogus expenses and gift cards were reimbursement for Walmart’s secret anti-union campaign. Is this an attempt to pressure Coughlin to take the hit to his reputation in order to regain what is likely the bulk of his fortune?
Walmart says that its internal review turned up no evidence that Coughlin had used the money in anti-union activities. Well, duh, wasn’t that the point? Coughlin used to be Walmart’s Chief of Security and it wouldn’t surprise me if he had documentation buried under a rock somewhere as an insurance policy. I also find it deeply suspicious that a company famous for its systems and controls on everything let a half million dollars just walk out the door. On the other hand, it is a little difficult to believe that Walmart and Coughlin paid off union spies with hunting rifles, dog fences on Coughlin’s property and cowboy boots custom made for Coughlin’s feet. He will undoubtedly claim that this was part of some reimbursement scheme but it sounds a bit fishy to me. At this point we are anxious to hear Coughlin’s defense and open to see if he has compelling evidence that he was doing black bag work at Walmart’s behest.
As for Coughlin, in the end he will likely be viewed as a powerful person run amok for what, in the context of his position and net worth, was chump change. It never ceases to amaze me how cheaply some people are willing to sell their integrity. It can take twenty years to build a reputation and only a week or two to tear one down. As this story unfolds, there are likely to be no winners and two losers.
Most toy manufacturers that we have been talking to have voiced frustration (and worse) to retailers’ refusal to let them push through price increases despite higher costs for oil, resin, transportation, electricity in China, etc. The retail attitude seems to be “We want OUR prices and OUR margins – take it out of your end!” Charming. This has lead manufacturers to take plastic and features out of products which curbs innovation, jeopardizes product quality and consumer safety. Some have even cancelled orders as they have become unprofitable.
Here at Toyjobs Monthly, we may have stumbled onto a solution. Walmart’s earnings have been increasing an average of 17% annually over the last five years and are forecasted to grow an annual average of 15% over the next five. However, the company’s share price is actually less than it was in 2000. For the last five years the company’s P/E ratio has been in the mid thirties but now stands at 18X 2005 estimated earnings.
Walmart’s stock is cheap and not likely to remain so over the long haul. Our proposed solution is to take the nickels and dimes that you’re able to squeeze out of Big W and invest them in the company’s shares. That may be the best way to make money from Walmart.
In this issue, we have provided comprehensive prognostication on the future of China’s economy and a Readers’ Digest version of what Sergio Zyman is likely to say at the coming Kid Power Conference for anyone who either won’t be in attendance or is looking for a way to slip out early for a round of golf.
All the best,
Tom Keoughan
