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Toys R Us Bankruptcy: It’s Not All About Amazon

Summary:
Toys R Us filed for bankruptcy earlier this week, a wicked head-shot to a retail sector that’s been reeling for months.The TRU filing ranks as the second-largest US retail bankruptcy ever, according to S&P Global Market Intelligence.Toys R Us had .6 billion in assets at the time of filing. Only Kmart was bigger. It had .3 billion in assets when it went bankrupt in 2002. Crushing debt pulled the giant toy seller under. According to a report, the company has piled up more than billion in debt. Toys R Us reportedly pays more than 0 million a year on debt service alone.The company says it plans to continue operating and secured a.1 billion operating loan to stabilize operations.This is the biggest and perhaps most visible retail bankruptcy of the year, but Toys R Us is far

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Toys R Us Bankruptcy: It’s Not All About Amazon

Toys R Us filed for bankruptcy earlier this week, a wicked head-shot to a retail sector that’s been reeling for months.

The TRU filing ranks as the second-largest US retail bankruptcy ever, according to S&P Global Market Intelligence.

Toys R Us had $6.6 billion in assets at the time of filing. Only Kmart was bigger. It had $16.3 billion in assets when it went bankrupt in 2002. Crushing debt pulled the giant toy seller under. According to a report, the company has piled up more than $5 billion in debt. Toys R Us reportedly pays more than $400 million a year on debt service alone.

The company says it plans to continue operating and secured a$3.1 billion operating loan to stabilize operations.

This is the biggest and perhaps most visible retail bankruptcy of the year, but Toys R Us is far from alone. To say the retail sector is struggling would be an understatement of epic proportions. summed up the retail landscape pretty succinctly.

The filing is the latest blow to a brick-and-mortar retail industry, which has seen a string of bankruptcies from Payless Inc. and Gymboree Corp. to Perfumania Holdings Inc. Chains are reeling from store closures, sluggish mall traffic and the gravitational pull of Amazon.com Inc.’s lower costs and global home delivery. More than 10% of US retail space, or nearly 1 billion square feet, may need to close, convert to other uses or renegotiate rent, according to data from CoStar Group.”

The air is rushing out of the retail bubble. It’s easy to finger-point at the internet and blame it for the black cloud enveloping the brick and mortar retail sector. But in truth, it’s not all Amazon’s fault. During a podcast last spring, Peter Schiff put his finger on a more fundamental problem.

While online sales have increased significantly, they still don’t make up for the total decline in sales in brick-and-mortar stores. Peter believes the problems in the retail sector reveal disturbing economic truths about middle America.

Another reason people are shopping on the internet, other than just the convenience of not leaving your house when you’re doing your shopping, is the fact that the average American shopper is broke. They can barely afford to buy the stuff that they’re buying. In fact, most people are buying stuff that they can’t afford. They’re just buying anyway and they’re using a credit card…Retailing is a shrinking market because Americans’ pocketbooks are shrinking, their paychecks are shrinking.”

Data on consumer debt backs up Peter’s contention that Americans are putting a lot of their purchases on plastic. Over the summer, credit card debt eclipsed a record set during the summer of 2008. Americans carry $1,021.7 billion of revolving debt. Overall, credit card balances went up $4.1 billion in the month of July alone. Overall household debt is also at record levels.

Clearly there is something more going on here than Amazon changing the way Americans shop. E-commerce has certainly altered the retail landscape, but its existence does not account for all of the problems we see in the sector. Peter said it all points to fundamental economic weakness.

Wall Street can just be very dismissive about this and very complacent just chalk it all up to, ‘Hey, this is just automobile putting the buggy whip manufacturer out of business.’ This is not what’s happening. This is a sign of real problems in the US economy.”

The story behind the Toys R Us bankruptcy gives us a glimpse at a fundamental problem eroding the strength of the US economy – easy money created by Federal Reserve monetary policy. The ability to borrow a lot of money at low interest rates fuels borrowing and speculation. Malinvestment distorts the economy and inflates bubbles that eventually pop. This is the story of Toys R Us. An article in Forbes explains what happened.

In 2005 KKR and Bain Capital (which included former Presidential candidate Mitt Romney) bought Toys R Us for about $6.6 billion, plus assuming just under $1 billion of debt, for a total valuation of $7.5 billion.  But the private equity guys didn’t buy the company with equity.  They only put in $1.3 billion, and used the company’s assets to raise $5.3 billion in additional debt, making total debt a whopping $6.2 billion.  Total debt was now a remarkable 82.7% of total capital!  At the time of the deal interest rates on that debt were around 7.25%, creating a cash outflow of $450 million/year just to pay interest on the loans. At the time Toys R Us was barely making a profit of 2% – so the debt was double company net profits.”

The Fed dropped interest rates in 2002 in response to the dot-com collapse. Rates were creeping back up in ’05, but they were still at low levels. The Fed wanted people to borrow and spend to “stimulate the economy.” They did. The equity guys would have found it much more difficult to swing this kind of deal in a normal interest rate environment. This vividly illustrates how the central bankers feed the business cycle and the unfortunate side-effects of their policies.

The retail bubble began to inflate in the 1990s and early 2000s. Hundreds of stores opened. Monetary policy helped keep the bubble inflated. The Federal Reserve has held interest rates low for nearly a decade and engaged in other monetary policies meant to stimulate consumption. The goal? Keep consumers spending money. It’s worked. Americans have opened their pocketbooks and kept the retail blimp afloat.

Earlier this year, Urban Outfitters CEO Richard Haynes warned the retail bubble has popped.

This created a bubble, and like housing, that bubble has now burst. We are seeing the results: Doors shuttering and rents retreating. This trend will continue for the foreseeable future and may even accelerate.”

The retail landscape is undeniably changing rapidly. Amazon is a major factor. But you can’t pin every retail woe on the online giant. Companies saddled with debt can’t respond to a changing marketplace. The Fed has played a role in inflating this bubble. But it will shoulder none of the blame, at least not in the mainstream world of economic punditry.



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