Reviewing first day motions from a company's chapter 11 docket, and more specifically the CEO's declaration, can be a great way to learn exactly what happened in the days/weeks leading up to a bankruptcy filing. The company spends millions of dollars every month on expensive lawyers (Kirkland & Ellis in the case of Toys "R" Us), investment bankers (Lazard), turnaround advisors (Alvarez & Marsal), claims administrators, etc., who all spend many sleepless nights in the days leading up to a filing trying to make sure the first day motions are as informative as possible.
With those high expectations, you can imagine our surprise when we opened the Toys "R" Us CEO's declaration to find this "preliminary statement":
Yes, Kirkland & Ellis was paid $800 an hour (ish) to type up the Toys "R" Us jingle in a court filing. Bravo!
In any event, once you get beyond the amateur-hour antics, CEO David Brandon explains why Toys "R" Us was forced to file for bankruptcy in such a hurry. While debt service on a excessively levered capital structure was a big part of it, Brandon explains that media speculation over a potential bankruptcy filing led to a rapid tightening of trade terms just as the company was trying to build inventory ahead of the holiday season. Here are the details:
1. Debt - Apparently spending the majority of your FCF
(free cash flow)
on debt service while ignoring capital improvements and store remodels is a bad long-term business strategy for a bricks-and-mortar retailer.
Toys “R” Us, however, has been operating for more than a decade with significant leverage, necessitating the use of substantial amounts of cash each year (approximately $400 million) to service the more than $5.0 billion of funded indebtedness. But these substantial debt service obligations impair the Company’s ability to invest in its business and future. As a result, the Company has fallen behind some of its primary competitors on various fronts, including with regard to general upkeep and the condition of our stores, our inability to provide expedited shipping options, and our lack of a subscription-based delivery service.
2. Vendors - Media speculation of an imminent bankruptcy filing starting on September 6th caused 40% of vendors to restrict shipments and demand "cash on delivery" for new inventory purchases which would have required $1 billion incremental liquidity.
More recently, the Company’s need for a comprehensive solution to its capital structure issues caused widespread “bankruptcy” speculation in the media, leading to a severe constriction in the Company’s trade terms. More specifically, in late July the Company hired Kirkland & Ellis LLP and Alvarez & Marsal North America, LLC, complementing its retention of Lazard, to consider restructuring and capital structure solutions.
A news story published on September 6, 2017, reporting that the Debtors were considering a chapter 11 filing, started a dangerous game of dominos: within a week of its publication, nearly 40 percent of the Company’s domestic and international product vendors refused to ship product without cash on delivery, cash in advance, or, in some cases, payment of all outstanding obligations. Further, many of the credit insurers and factoring parties that support critical Toys “R” Us vendors withdrew support. Given the Company’s historic average of 60-day trade terms, payment of cash on delivery would require the Debtors to immediately obtain a significant amount—over $1.0 billion—of new liquidity.
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