Matthew Kandrach – President, CASE

October 8, 2018 – https://bit.ly/2CxCar6

As Toys R Us creditors vie for control of struggling retail companies to claw their way to the top of the priority claims list, the result is a continued game of retail roulette with thousands of jobs on the line.

Oaktree Capital Management, one of the lead creditors who forced liquidation over keeping Toys R Us open with a smaller footprint is again making headlines around its attempt to strong arm the bankruptcy process concerning the hedge fund’s retail investments. Jewelry and accessories chain Claire’s Stores Inc. in court papers last week blasted debtholder Oaktree’s opposition to its plan for emerging bankruptcy, arguing it cannot wait for a proposed alternative.

Illinois-based Claire’s, which has 5,300 U.S. stores and 7,500 worldwide, entered Chapter 11 in March under a restructuring support agreement with its first-lien lenders and its largest equity holder, affiliates of Apollo Global Management LP. Early in the bankruptcy process, attorneys tried to differentiate the filing from the recent Toys R Us chapter 11 proceedings claiming that the fellow iconic children’s store faced “a large senior group of creditors who preferred a liquidation from the outset” while, with Claire’s, “all stakeholders believe in the business and support a going-concern reorganization.”

Oaktree’s statements might be mere court posturing against growing scrutiny on the role creditors have played in the recent influx of bankruptcies and their refusal to join private equity efforts to support the displaced employees. The creditor group led by Oaktree was the only stakeholder not to vote overwhelmingly in favor of the reorganization plan, according to a preliminary analysis of the ballots and only came to the table to negotiate after a failed attempt to purchase the struggling retailer outright. Under the tentative deal that will allow the company to move forward with plans to restructure and emerge from bankruptcy, the Oaktree-led creditors will see their cash recovery rate increase from $3 million to roughly $41.8 million, with the opportunity to walk away with up to $16.3 million more, if certain earnings thresholds are met in 2019 and 2020.

The fact that Oaktree-led creditors held the power to decide if Claire’s would live or die, makes it clear that lack of credit, not too much debt, killed Toys R Us.

A recent Wall Street Journal article largely confirmed the conclusions of my previous Morning Consult piece, which explored what went wrong with America’s favorite toy seller, what could have been done to prevent its demise, where to place blame, and if there are any lessons to be learned.

Nearly everyone seems to have jumped to the conclusion that the Amazon-led cataclysm in the retail marketplace was predictable, and that the $7.5 billion leveraged buyout of Toys R Us by private equity firms KKR & Co., Bain Capital, and Vornado Realty Trust was the root cause of its fall. I argued that in fact “the role of debt and credit in the American economy and the sustainability of Toys R Us was never considered beyond the company’s demise and the connection to the private equity firms that tried to save the business and its employees.”

In reality, Toys R Us was swallowed up by the trend of credit managers becoming much more aggressive and litigious as the number and value of distressed-investing opportunities diminish. The distressed-debt creditors in question — Solus Alternative Asset Management, Angelo, Gordon & Co., Franklin Mutual Advisers, Highland Capital Management, and Oaktree Capital — were deeply anxious to maximize value, and forced the liquidation issue even as Toys R Us planned its reorganization and as multiple potential sales of the company were under development.

The Wall Street Journal’s reporting definitively backs up these assertions, noting that by June 2018 Solus was the “largest holder in the debt issue known as B4,” and that was important because B4 “became pivotal to the reorganization effort because its holders had supplied collateral for additional bankruptcy financing,” meaning “they had the power to essentially stop the clock on the reorganization effort.” As I noted in early August, ultimately “it was lack of access to credit, not debt, that crippled Toys R Us as it attempted to restructure and emerge from bankruptcy.”

There was a way forward for the company, but its creditors had little patience and a huge appetite for maximizing their returns — whatever the cost. We do neither ourselves nor consumers a good service by lazily assuming private equity is to blame and ignoring the role played by Toys R Us’ creditors in its demise. This was not the first, and will certainly not be the last, time an American company is felled by manufactured liquidations in the distressed debt market, with major implications for jobs, the economy, consumer choice and prices, and competition.