With the somewhat surprising recent Chapter 11 filing for Toys “R” Us, renewed skepticism concerning the fate of brick and mortar retailers emerges. However, a closer examination of the causes for the Toys “R” Us reorganization attempt points a finger not solely at the retail environment, but, more importantly, at the underlying and inherent anatomy of a leveraged buyout (LBO). Apparently, Toys “R” Us has been suffering from many of the maladies that affect traditional retailers today, and that environment has contributed to the many insurmountable obstacles facing the toy and children’s retailer. Moreover, an analysis of the structure and foundation of an LBO points to a prescription for a potential financial disaster when monstrous LBO debt burdens a brick and mortar retailer.
An LBO occurs when a profitable publicly held company receives a tender offer from an acquirer (usually a hedge fund or some other investment vehicle). Shareholders of the target company are offered a multiple of net worth of the company as an inducement to sell their shares and relinquish their ownership interests in the profitable entity. In order to finance the purchase of the shares of stock, the acquirer has the target company borrow the funds necessary to purchase the stock from the public shareholders and uses the assets of the company as collateral for the loan.
