Not all fun and games

Play time is over for Toys R Us owners

Toys R Us has proved a disappointing financial plaything. A decade after buying the Barbie-to-Nintendo retailer for $6.6 billion, the three owners - Bain, KKR and Vornado Realty Trust - are holding worthless equity, according to a Breakingviews analysis. The new chief executive, David Brandon, formerly of Domino's Pizza, will have his work cut out to deliver improvements.

Focused merchants such as Best Buy, Staples and Barnes & Noble have been clobbered by the twin bullies of mega-stores like Target and online powerhouse Amazon. Toys R Us is in a class with these stragglers. Sales have tumbled 11 per cent since 2010-11, to $12.4 billion in the year to January 31, and its operating margin has shrunk to about 5 per cent.

The toy chain's three troubled counterparts command an average enterprise value multiple of 5.7 times Ebitda, according to Thomson Reuters data. Attach that multiple to the $642 million that Toys R Us generated in the year to January 31, and the enterprise would be worth about $3.7 billion. Subtract net debt of $4.1 billion and the equity is worth less than nothing, against the $1.2 billion the owners contributed to buy the company.

Some niche-like chains have found a way to avoid a beating. Michaels, Party City and Williams-Sonoma, for example, are expected to increase revenue collectively by almost 6 per cent in the coming year with average operating margins of 16 per cent. They fetch an enterprise value-to-Ebitda multiple of around 10 times.

Toys R Us already plans to slash another $175 million of costs. If Brandon can enhance the company's online appeal and lure customers back into stores, perhaps Toys R Us could piece together annual sales growth of 2 per cent and expand its operating margin to 8 per cent by 2018. Then maybe it would sell for eight times Ebitda. Assume steady net debt, and the equity would be worth $4.3 billion.

Barring any financial wizardry such as a Toys R Us breakup, the three owners could then lay claim to an annualised internal rate of return of 10 per cent over 13 years, before any costs. That kind of turnaround would be some toy story.