They Come Under “Intense Scrutiny” by the Pension Funds that Feed Them. But this too shall pass.
For the past three mornings, Toys ‘R’ Us has tweeted the countdown of its demise:
- On Saturday: “Only 6 Days Left! #toysrusclosingsale”
- On Sunday: “Hurry! Only 5 Days Left! #toysrusclosingsale #toysrus #babiesrus #alwaysatrukid”
- And on Monday: “Hurry! Only 4 Days Left! #toysrusclosingsale #babiesrus #toysrus #alwaysatrukid”
On June 29, its remaining stores in the US will close. And then it’s over of the iconic retailer — one more victory for PE firms that have plowed into retail during the leveraged buyout boom before the Financial Crisis, loaded them up with debt, and watched them collapse in what I have come to call the brick-and-mortar meltdown. Toys ‘R’ Us is just one of them.
PE firms Kohlberg Kravis Roberts (KKR), Vornado Realty Trust, and Bain Capital Partners acquired the publicly traded shares of Toys ‘R’ Us via a $6.6 billion LBO in 2005. They funded the acquisition in large part by loading up the acquired company with debt — hence “leveraged buyout.” In other words, the PE firm had little skin in the game, and over the years extracted $400 million in fees even as the retailer died.
The 33,000 employees, when it is all said and done in a few days, will be out of a job.
In a sense, the end came very rapidly, after 13 years of building up to it under the PE-firms’ iron cost-cutting fist. The meltdown started in early September when rumors emerged that Toys ‘R’ Us had hired a bankruptcy law firm. Its bonds collapsed on the spot. On September 18, the company buckled and filed for bankruptcy, assuring everyone that it would go on as a going concern. In early March, it became apparent that liquidation would be next. On March 15, the company announced it would liquidate all its operations in the US and Puerto Rico. And it began “final liquidation sales” at all its remaining Toys“R”Us and Babies“R”Us stores.
Among the biggest investors in PE firms are public pension funds. They provide about 20% of the $3 trillion in assets managed by PE firms. Public pension funds like the accounting of investing in PE firms: These investments are considered illiquid and long-term and don’t get marked-to-market. This gives pension funds the illusion of stability during times of market turmoil, and they don’t mind the sky-high fees. And PE firms love public pension funds because that’s where the money is – and the sky-high fees. It’s a symbiotic relationship.
But the Toys ‘R’ Us demise under the auspices of KKR, Bain Capital and Vornado Realty Trust has rattled some nerves, including at the $129-billion Washington State Investment Board (WSIB), which has been investing in KKR for over 30 years, making it one of the earliest backers. According to the Wall Street Journal, it invested in at least 23 KKR funds, including $1.5 billion in the fund that contained the Toys ‘R’ Us investment.
The WSIB held a meeting last Thursday discussing its investment in KKR and KKR’s account of the Toys ‘R’ Us debacle. A recording of the meeting was heard by Bloomberg News:
“Did anyone at KKR lose their job over the failure of Toys ‘R’ Us?” asked WSIB member Stephen Miller. “Did anyone have their bonuses cut? Did anyone have their compensation cut significantly? Because that’s one of the consequences of free-market capitalism.”
KKR’s head of consumer retail for the Americas Nate Taylor was at the meeting, volunteering for PR purposes to have his feet held to the fire. He replied to Miller that no one who led the LBO at the time was with KKR anymore.
“We’re here to be transparent, to acknowledge where we’ve made an investment mistake, and we certainly did at Toys, and be helpful in making sure that all of you understand what we’ve done and what the facts are around this situation,” he said.
It worked. WSIB then voted to commit another $200 million to KKR, this time to the KKR Global Infrastructure Investors III LP fund and a sidecar fund.
On June 14, the $93.5-billion Minnesota State Board of Investment – the agency in charge of retirement funds, trust funds, and cash accounts – voted to temporarily suspend future commitments to KKR after hearing testimony “that raised concerns about the management of Toys ‘R’ Us and its employees,” a representative for the pension told the Wall Street Journal. The board wants to “conduct further inquiry into these concerns,” the representative said.
Minnesota Governor Mark Dayton had requested the freeze. No final decision has been made yet, and I’m sitting at the edge of my chair waiting for the outcome. Because, according to the Journal:
Minnesota has invested in numerous KKR vehicles, including a $150 million commitment to the flagship KKR Americas XII Fund, which closed last year. It had exposure to Toys ‘R’ Us through a $200 million commitment to the KKR Millennium Fund, the vehicle that held the investment.
The collapse of Toys ‘R’ Us focused “intense scrutiny” – as the Journal put it – on KKR, Bain Capital, and Vornado Realty Trust:
Points of criticism have included Toys ‘R’ Us’ heavy debt burden, the millions in fees that its private-equity backers earned, and the roughly 33,000 workers expected to lose their jobs without any severance pay.
But this too shall pass. After Toys ‘R’ Us is liquidated, it will fade into distant memory. But the symbiotic relationship between public pension funds and PE firms will go on as vibrantly as before. And as far as pension funds’ “intense scrutiny” of PE firms is concerned, it’s all just lip service.
This is another retailer that was bought out by a PE firm, saddled with $8 billion in debt, and now grapples with its fate. Read… Is This the Next Big Retailer to Melt Down? Its Bonds Crashed
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