Toys ‘R’ Us: Could Its Buildup Blow Up?

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? 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. The
web business also is attractive. Over the years, Toys "R" Us has been smart
to buy up operators like eToys.com, FAO.com and babyuniverse.com. 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. 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. Tom Taulli is the author of
various books, including "All About Commodities." He does not own a position
in any of the stocks named here.