Case Questions #5
Toys “R” Us LBO
1. What are the risks and merits of the transaction?
This LBO transaction has both risk and profit potential. KKR, Bain, and Vornado Realty Trust face risk because the industry that Toys “R” Us (toys) is currently in, the retail toy industry, is in a decline. Industry sales have been down 4% in the last year, and analysts don’t have a positive projection for future sales in the US. This declining industry, and threat of new competitors such as Walmart and Target, make it hard to be profitable which makes it extremely risky for KKR, Bain, and Vornado. Another factor that needs to be considered when calculating risk, is that this transaction is a club deal, meaning that more than one private equity firm will have control. This is risky to each firm because they will have limited control and will not have the power to dictate the transaction exactly how they wish. Although there is risk in this transaction, there is also some merit. First, Toys is a very big company that has a lot of cash flow. This is ideal for a LBO transaction because it has enough cash flow coming in to pay off debt that it leverages. Also, since Toys is facing some hard times and currently struggling to compete in the market, it is very likely that KKR, Bain, and Vornado can purchase Toys at a good premium. In addition, the retail toy industry is seeing new growth in Europe. This is a good thing for and LBO transaction because it offers more opportunity for an exit strategy since they will be able to expand into European markets. 2. Summarize the industry dynamics, including the major issues and potential catalysts for improvements. In 2005, the U.S. retail toy industry was not looking too promising. Sales were down 4% in the industry from 2004 to 2005. Although there was growth in some subcategories, dollar sales in the industry declined for a third consecutive year. One threat to the industry was the new trend of younger...