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The Toys “R” Us LBO Case Solution & Answer

 The Toys “R” Us LBO Case Solution 

Executive Summary

Toys “R” Us is a recognized and a valuable US based Toys Retail Company, which was founded in 1948. It is the specialty retailer of baby products, toys and children’s apparel.The demand of the products in the industry is dependent more on the economic aspects, disposable income of consumers and changing behaviors of the customers to cease their spending. Furthermore, the strong segment of company is Babies R, but it is not in a good position currently; therefore, the value of Babies R could be better. The company is highly vulnerable to the intense competition in the market, which in turn makes it very challenging & risky for KKR, Bain Capital and Vornado Realty to buy Toy Company. The private equity investors can create value in the transaction of leverage buyout through various methods, such as: multiple expansion, debt expansion and operational improvements. The winning bid for the company is 26.75 dollars per share, which represents an aggregate value of 6.7 billion dollars, including the fee of transaction. There are various exiting strategies that are recommended for this investment, such as: to exit and sell the company, they can participate in the Initial Public Offerings as the company is not public currently. Another exit strategy is that the consortium can sell the company to the strategic buyer, such as: Target and Walmart. Furthermore, they can also sell Toys to other financial investors, such as: another private equity firm.

Company Overview

Toys “R” Us is one of the recognized and valuable US based Toys Retail companies, which was founded in 1948. It is the specialty retailer of baby products, toys and children’s apparel. The company expanded its business operations through product diversification and geographic divarication.  The company prides itself on providing valuable and high quality products to its customers, which in turn provides competitive edge to the company. Internationally, Toys “R” Us  operates 601 stores and it has 1499 retail stores-throughout the world.

The worldwide toy business of the company ishighly seasonal with net earnings and sales highest in the fourth quarter. The continued success and growth of the company is based on offering the memorable shopping experience to its customers with toy-trained sales staff, unique feature shops and exclusive, in-demand and classic products. The company has greatly suffered from both increased competition from discount/mass channels, such as: Target and Walmart as well as from the downstream demand.

Industry Dynamics

The industry is highly competitive and concentrated as the industry is dominated by the leading producers and competitors, including: mass and discount merchandisers, national and regional chains, electronics retailers and local retailers. The competition in the market is highly based on quality, product differentiation, product selection, promotion and advertising, location of the store and price of the products. The competitors use aggressive pricing strategy to accelerate their efforts in meeting the changing demands of the customer,on time.

The retail toy industry is at the mature stage of the product life cycle curve, which has been experiencing a robust growth in the 1990s, and it is expected by the industry experts and analysts that the traditional toy and games market would be expecting a 0-2% growth within 3 to 5 years. Furthermore, the online toy sales has continued to rise, generating 2.6% increase in the last year,generating more than 1.3 billion dollars in 2005.

In the toy retail industry, the sales are not up to the market due to the global economic downturn in the market. Thus, the demand of the products in the industry, is dependent more over the economic aspects, disposable income of consumers and changing behaviors of the customers, to cease their spending. The industry is-facing an intense competition from the discount departmental store and small stores. Furthermore, the toy market retailers are experiencing significant changes in the market due to the invasion of the imported products, which in turn has fueled the industrial competition.

Another factor that could be considered in the industry dynamics, includes: age compression. Nowadays, children are more diverted towards electronic apps&video games as compared to the traditional toys. Additionally, the customers have shown their willingness in purchasing the products that tend to help the children in learning and in their development. The success of the incumbent firms, is based on their ability to follow and identify the product demand and trends. If the retailer underestimates or overestimates the demand;it would have significant shortage and excess of inventory.

Investment Merits and Risks

Merits

The major benefit of the transaction is that the target company is the valuable and renowned toy manufacturer in the international toy industry. Along with strong market position and high market share; the company is expected to have growth in sales, if the assumptions and planning made by the company turn out to be effective. Furthermore, the strong segment of company is Babies R,it is not in a good position currently; therefore, the value of Babies R could be better as well. The company’s international segment is performing exceptionally well, and the company also owns real estate portfolio acts as its protection in adverse conditions. The strong brand name and brand equity are other merits of the transaction as the company is successful in maintaining its position in the highly competitive market despite of having adverse conditions of economy.

Risks

The sales of the retail toy industry totaled 21.3 billion dollar in 2005, down 4% from 22.1 billion dollars in 2004 and analysts are unable to show a positive forecasting for the future sales in the US. The company is highly vulnerable to the intense competition in the market, which in turn makes it challenging & risky for KKR, Bain Capital and Vornado Realty to buy the Toy company. Furthermore, the price of transaction is high, with an inclusion of the momentous leverage. The company is confronted with the issue in terms of liquidity, due to the unpredictable nature of the industry, because of the seasonal sales and risks.(Firestone, 2012).

Value Creation Potential

The private equity investors can create value in the transaction of leverage buyout through various-methods, such as:multiple expansion, debt expansion and operational improvements. Additionally, private equity investors could use strategy to create value by unlocking the value in faster growing asset through selling the international Toys “R” Us business or spinning off Babies “R” Us. The success of the LBO is based on the usage of“borrowing” to finance the transaction. The financial advisor can create value in the LBO through the operational enhancement, such as: cost cutting, organic growth and realization of synergies from add-on acquisition. The valuation multiple expansion can create value for the private equity investors; however that expansion of market valuation multiple is market driven & beyond the company’s control………………….

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