Ask the grumpies: What the heck happened to Toys R Us?

Leah asks:

Trying to understand leveraged buyouts: why are they done, and why, legally, can it happen even if the people in the company don’t want it to happen? One of my friends was making noise about how Toys R Us didn’t go under due to a bad business model. He said it was due to a leveraged buy out and the company being saddled with debt. How does that even work?

We don’t really know.   Which isn’t to say that people don’t know, I mean, there’s definitely some knowledge that Mitt Romney’s company killed it by doing a leveraged buyout in 2005, but we don’t really understand the whole leveraged buyout thing and why it’s allowed given that it can destroy companies at minimal risk to the hedge fund doing the destruction.  Seems like something government should be regulating better, but isn’t.

Here’s a brief explanation on why Toys R Us went under from CNN Money.

Here’s bloomberg with a longer explanation.

Here’s NBC News.

More detailed info on how leveraged buyouts are supposed to work and that it didn’t in this case.

The Atlantic also explains at length.

8 Responses to “Ask the grumpies: What the heck happened to Toys R Us?”

  1. nicoleandmaggie Says:

    So…turns out there’s a ton of evidence that trump directed people to lie to congress. That should be enough to start impeachment proceedings. Today is a good day to call your senators to suggest exactly that. There’s no 5calls script, but you can call anyway.

  2. Bardiac Says:

    I REALLY don’t understand why a company would buy another company intending to bankrupt it. Wouldn’t the original company lose a money doing it? Or do they think loading the purchased company with debt will help it do well?

    • nicoleandmaggie Says:

      The idea is that they make the company do better not because of debt but because they restructure or something and then the company makes money and is easily able to pay off the debt.

      I don’t know. Obviously in practice this does not work and it’s really just a way to make money using bankruptcy laws and limited liability to limit downside to the hedge fund. It shouldn’t be allowed.

  3. nicoleandmaggie Says:

    Email from indivisible:
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    → The #TrumpShutdown continues, even though Republicans have the power to end the shutdown immediately. The Democratically-controlled House has passed several bills (with a liiiiitle bipartisan support) that would have brought the shutdown to an end, but Senate Leader McConnell refuses to put those bills to a vote — making him complicit in the shutdown and causing pain to hundreds of thousands of families.
    → Senate offices are reporting an uptick in pro-wall calls from constituents (yes, you read that right). They’re urging their senators to cut a deal to end the shutdown by including funding for the border wall. After yesterday’s disturbing news that the family separation crisis was more widespread than the public knew, it is clear that we cannot allow any funding for this administration’s immoral operations at the border to continue. Including Trump’s racist wall.

    Now, this doesn’t mean that there’s nothing we can do next week with recess on hold. The most important thing we can do is to keep up the pressure on our senators — both Democrats and Republicans.
    Take action to end the #TrumpShutdown

    We’ve revised our shutdown resource page with the latest news (and will continue keeping it updated), but our asks remain the same. For Republicans, ask them to put pressure on McConnell to bring bills that reopen the government to the Senate floor. For Democrats, oppose any “business as usual” legislation until the government is reopened.

    District office visits. Recess or not, Senate district offices will be open next week, and we need to turn out in force. And if there are town halls still scheduled, you should go! Share your event photos and videos with us on Twitter @IndivisibleTeam and use the hashtag #TrumpShutdown so we can help amplify.
    Phone calls. As long as the government is shut down, calls should be happening everywhere! We are organizing a National Call-In Day on Wednesday, January 23, so plan to make some calls to your senators on Wednesday along with Indivisibles across the country. We’ll follow up with more resources soon, but feel free to get a head start now — call 844‑236‑2373 to reach your senators.
    Support federal workers. We also encourage everyone to look for ways to provide direct support to workers and families directly impacted by the shutdown in your area. Whether through food drives, lending a hand to folks in your community, or other opportunities, there are a variety of ways to support these workers during the shutdown.

    Regardless of what’s going on in Washington, we are excited to support all of the community service work happening this Monday, January 21 for Dr. Martin Luther King, Jr. Day. If you haven’t looked into service opportunities yet, check events happening near you at MLKday.gov.

    In solidarity,
    Indivisible Team yesterday’s disturbing news

  4. Troy Says:

    First, it’s important to understand 2 things:

    1. The only leveraged buyouts that are covered in mainstream publications are the ones that end badly, like Toys “R” Us. For every one of these which fails, there are dozens that go unremarkably – basically, they continue operating and nobody pays much attention to the change of ownership – and a few that go incredibly well.

    For an example of the latter, see Silver Lake and Michael Dell’s leveraged buyout of Dell: https://www.theverge.com/2018/8/13/17644234/michael-dell-enterprise-technology-consumer-laptop-private-public-emc. It’s thriving in ways that would have never been possible with the prior ownership structure. Along the way, Silver Lake and Michael Dell did a different leveraged buyout of EMC and prevented EMC from what looked like a slow spiral into irrelevance.

    2. The “leveraged” in “leveraged buyout” means that part of the purchase price was raised as debt (that is, someone lent money to the buyers or to the company). That’s not phantom money or a loophole or something – it’s actual investors putting forth actual cash. If the equity (AKA ownership or shares) and/or debt becomes worthless (as looks possible with Toys “R” Us), the money is gone.

    Otherwise, there’s nothing inherently different about a “leveraged buyout” and simply purchasing a business. When you see the phrase “leveraged buyout,” read “purchased” (and often, acquisitions described as “purchases” also are mostly funded with debt – at least in mainstream publications, the phrase you encounter depends more on the writer’s goals than on the deal terms).

    This statement from an earlier comment has 2 inaccuracies: “Obviously in practice this does not work and it’s really just a way to make money using bankruptcy laws and limited liability to limit downside to the hedge fund”

    Obviously as Toys “R” Us shows, this doesn’t *always* work — sometimes because of the buyout and debt service, sometimes because the company already had too many problems, and sometimes due to poor execution (just like any other business). However, that’s a minority outcome, as #1 explains. (For lots more: http://www.fmaconferences.org/JAF2014//DebtStructurePrivateEquityReputationandPerformanceinLBOs.pdf)

    And they don’t “make money using bankruptcy laws and limited liability to limit downside to the hedge fund.” Nobody makes money from an outcome like Toys “R” Us. The equityholders will probably get wiped out and the debt will be repaid for a fraction of face value (ie, someone who lent $1 might get $0.30 back). Investors took a risk and lost a lot of their principal. The end.

    As a simple example, imagine a small lemonade stand. Someone wants to acquire it and the buyer and seller agree on a purchase price of $100. The buyer recognizes that this is a fairly high-risk business and is willing to put $25 of their own money into the purchase. The buyer gets 3 friends to invest $25 each, and the $25 is $12.50 of equity (that is, ownership – it doesn’t need to be repaid) and $12.50 of debt (that is, a loan which does need to be repaid, but has far lower, fixed returns). This is a leveraged buyout. It’s equally accurate to simply call it an acquisition or a purchase — there’s nothing magical to it. Imagine that the lemonade stand does poorly over the next few years and its enterprise value declines from $100 to, say, $40. That $40 is basically just enough to cover the debt (3*12.50 = $37.50). The original buyer who put up $25 as equity will not get any of it back. (The split between equity and debt varies based on the deal and the investor, but these percentages are fairly realistic — as you’d imagine, the 3 outside investors want to see that the lead buyer has enough of their own money at risk that it matters to them.)

    Finally, one other thing is worth noting: at least among very large companies, those which are acquired by funds (rather than acquired by other companies in their industry because the acquired company is considered strategic) tend to be either distressed or at least facing headwinds – like, say, almost all brick-and-mortar retailers. One can debate what would have happened to Toys “R” Us, but it’s worth noting that the set of large companies which are acquired by funds has significant sample bias: a higher percentage of them would have performed poorly on their own than equal-size peers. In general, the funds are looking for companies which already have some problems (and conversely, shining stars tend to be acquired by other companies rather than by investment funds).

  5. T Says:

    Comment part 1

    Trying to understand leveraged buyouts: why are they done, and why, legally, can it happen even if the people in the company don’t want it to happen?

    There’s a lot of misinformation about leveraged buyouts, both in general and in this blog post. First, it’s important to understand 2 things:

    1. The only leveraged buyouts that are covered in mainstream publications are the ones that end badly, like Toys “R” Us. For every one of these which fails, there are dozens that go unremarkably – basically, they continue operating and nobody pays much attention to the change of ownership – and a few that go incredibly well.

    For an example of the latter, see Silver Lake and Michael Dell’s leveraged buyout of Dell: https://www.theverge.com/2018/8/13/17644234/michael-dell-enterprise-technology-consumer-laptop-private-public-emc. It’s thriving in ways that would have never been possible with the prior ownership structure. Along the way, Silver Lake and Michael Dell did a different leveraged buyout of EMC and prevented EMC from what looked like a slow spiral into irrelevance.

    2. The “leveraged” in “leveraged buyout” means that part of the purchase price was raised as debt (that is, someone lent money to the buyers or to the company). That’s not phantom money or a loophole or something – it’s actual investors putting forth actual cash. If the equity (AKA ownership or shares) and/or debt becomes worthless (as looks possible with Toys “R” Us), the money is gone.

    Otherwise, there’s nothing inherently different about a “leveraged buyout” and simply purchasing a business. When you see the phrase “leveraged buyout,” read “purchased” (and often, acquisitions described as “purchases” also are mostly funded with debt – at least in mainstream publications, the phrase you encounter depends more on the writer’s goals than on the deal terms).

    • nicoleandmaggie Says:

      The part you’re not understanding who who bears the risk when things go bad. Yes, everything is great when things go well. But the hedge fund does not bear the true cost when things go bad, only the company they leveraged does. That causes the exact same kinds of problems that caused the recession– companies taking larger risks than they would have had they had to bear the true cost.

  6. nicoleandmaggie Says:

    Hoo boy, there were a lot of rude and mansplainy posts from Troy in the spam filter. I freed up the two that were the most polite and rational. Take them as you wish. This isn’t the area of economics I study, but I’m not an idiot either.


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