Sears, Toys R Us look to survive ’18
Retailers take divergent paths on road to survival
With debt piling up and stores bleeding cash, two iconic American retailers chose sharply divergent survival strategies in 2017.
Sears Holdings opted for a host of complex financial maneuvers, store closures and asset sales designed to stave off what many analysts say is now inevitable — a date with bankruptcy court.
But Toys R Us acknowledged it was unable to pay its bills without protection from its creditors and filed for Chapter 11 bankruptcy in September.
Their separate paths may yield different outcomes in 2018.
The future at Sears is more doubtful than ever as sales continue to plunge despite the company’s attempts to stabilize the business. Toys R Us is heading for a fresh start after likely closing unprofitable stores, shedding debt and thus freeing up cash to reinvest in digital infrastructure and re-establish trust with jittery suppliers.
“It may be that bankruptcy was always meant to sort out which businesses should continue and which we don’t need anymore,” said Melissa Jacoby, a bankruptcy law professor at the University of North Carolina.
For now, Sears continues shrinking. When Sears and Kmart merged in March 2005, they had a combined 2,350 stores. In 2017, the company announced several rounds of closures totaling more than 400 locations, leaving it with about 1,000 after the holiday shopping season.
The company sold off its prized Craftsman tool brand to Stanley Black & Decker to raise cash and engineered several debt maneuvers to tie additional assets to its loans, which could eventually lead to secured creditors collecting key Sears property in a bankruptcy.
When talking to analysts and others who follow Sears, there’s a common thread: The company has avoided bankruptcy largely because of one person: CEO and shareholder Eddie Lampert. He has invested several rounds of capital in the retailer to help keep it afloat. But that’s not necessarily a good thing. Believers in the power of bankruptcy to provide a fresh start say the company must come to terms with its reality.
“I’m amazed that Sears is still around,” said Lauren Beitelspacher, a marketing professor at Babson College and expert on retail management and buyer-supplier relationships. “Right now it feels more like a property firm than an actual retailer.”
Lampert’s financial moves and investments have temporarily propped up Sears, said Stephen Opper, a distressed debt analyst at Reorg Research, which tracks ailing companies. But eventually, he’ll have to decide whether to extend unsecured credit to Sears, which is much riskier than secured loans that come with collateral.
One of Sears’ biggest challenges, analysts say, is that its brand has faded.
“People that want the value buy are going to go to Walmart,” said Greg Luken, president of Franklin, Tenn.-based Luken Investment Analytics. “If they want the value buy with a little higher quality, they’re going to Target, and if they thought ahead, they ordered everything from Amazon. ... What is it I can get at Sears that I can’t get somewhere else with a better experience, more convenience or (that’s) less expensive?”
Many shoppers also report poorly stocked shelves, limited product selection and insufficient help in the stores.
“We will continue to sharpen our focus on our best Sears and Kmart stores, best categories, and best members, as we will build on the momentum of our actions to date and be better equipped to support our continued transformation,” Sears said in the statement.
For Toys R Us, which is aiming to restructure $5 billion in debt, analysts say the company has a better chance at survival because it can still deliver value to customers seeking a specific product and experience. But this holiday season “could be critical for those stores that are on the fence,’’ said Perry Mandarino, a retail restructuring expert with financial services firm B. Riley Financial.
While the fourth quarter is always a crucial time of year for retailers, it plays an especially important role for Toys R Us, typically delivering more than 80% of its adjusted earnings each year, said Kirk Ludtke, a managing director and senior analyst with Cowen and Co.
“I think the outlook for the domestic business is uncertain,’’ Ludtke said. “This holiday season will determine the scale of the domestic business when it emerges from bankruptcy, which will be probably between the summer of 2018 and early 2019.’’
The company, which was the nation’s first big-box toy retailer, has failed to keep up with online threats such as Amazon and lost market share to physical competitors such as Walmart and Target, which often sell toys at a discount Toys R Us can’t afford because, unlike those chains, toys are its sole product.
Analysts at investment-bank UBS estimated on Dec. 19 that 183 locations — or roughly 21% of the company’s U.S. stores — could be shuttered next year.
In a statement, Toys R Us said “decisions about our real estate portfolio will be made only after careful consideration about the best interests of our business. Any speculation about potential
store closures at this time is premature and likely to be inaccurate.’’
Prior to its bankruptcy filing, the Wayne, N.J.-based toy giant was facing immediate deadlines to pay off $400 million in debt by the end of the year, hindering its ability to plow money back into the business. Most urgently, that financial burden rattled the vendors who keep the retailer’s shelves stocked.
“The debt load was unsustainable,’’ said Charles O’Shea, a Moody’s retail analyst, noting that the company was constantly refinancing. “It’s almost like you’re waiting for another credit card offer in the mail to pay off the old one. That’s in effect what Toys was trying to do, and finally, the vendors got nervous.’’
Now, under the shield of bankruptcy protection, Toys R Us has the leeway to reduce its debt, seek lower leasing costs and review relationships with vendors who can also breathe easier since the court filing puts them at the front of the line to get paid.
The specific details around the resolution of Toys R Us’ debt still need to be worked out, O’Shea said. “Creditors obviously want a reasonable amount of debt left over because that’s part of their recovery,’’ he said.
Still, Toys R Us remains a giant player in the toy industry whose position could be strengthened if it gets its debt under control.
“People are buying the product,’’ O’Shea said. “We think the company is viable with a more rational debt structure.’’
Despite its challenges and current restructuring, industry watchers say there’s still a vital role for Toys R Us to play on the retail landscape. “I do think Toys R Us has a concept that is needed in the economy,’’ Mandarino said.
The company has taken steps to reshape the shopping experience. For example, it introduced an augmented-reality experience at its stores, which involves using a smartphone to view computer-generated images on top of a real-world environment. Toys R Us has also opened 42 playrooms where children can try out gadgets and games. And the company has revamped its website, focusing on its product expertise.
Randal Croudy and his fiancée Ange- lina Perez recently stopped at a Toys R Us in Elizabeth, N.J. And while they were there to shop for Perez’s 8-yearold son, Croudy said that wandering the giant toy shop’s aisles remained fun for him as well.
“Even now, as an adult, I like to go to Toys R Us,’’ Croudy said. “It’s an exciting place.”
Croudy wasn’t aware that the retailer had filed for bankruptcy protection, but he said that wouldn’t deter him from paying Toys R Us another visit to grab a few more gifts to stick under the tree. “It wouldn’t make me hesitate if they have something there that I need to get or that I want,’’ he said.
Brandon, the Toys R Us CEO, said the company’s goal would be to create a business plan during the first quarter of next year and to be out of Chapter 11 well before the end of 2018. “I think it’s fair to say that we have no interest in going through another holiday season while under the uncertainty associated with a restructuring,” he said.
Nick Williams, a distressed debt analyst at Reorg Research who tracks Toys R Us, said it’s unlikely Toys R Us will face liquidation at the culmination of its bankruptcy.
But he said the retailer could get substantially smaller as creditors fight for assets, potentially leaving the company’s international business as its crown jewel.