The failed toy chain had been sold to a group of private equity firms on the advice of management, which, five years ago, contended that the company's future performance had,
"been adversely impacted by significant developments in the retail toy industry."
The private equity shops hope to sell the retooled toy firm to public investors for something in the range of 1.5 times the $6.6B it cost the group to buy Toys R Us in 2005.
According to the IPO's prospectus, the toy firm's new management, under the private equity group, had performed major surgery on expenses. These are activities that tend to be one-off actions. You can't close the same store twice, multiplying the savings.
Berman frames the interesting question in the last paragraphs of his column,
"The question for future Toys "R" Us investors is whether there are still improvements and opportunities for left for the company which is in a notoriously competitive, low-margin business.
But the bigger challenge will be about setting the narrative. Do investors really want to play in the KKR sandbox? Toys "R" Us will be an important way to find out."
Precisely.
I've never found comfort in corporate performances which are the result of one-time, radical cost-cutting. Rather, my proprietary research provided me with evidence that consistent performance, over time, is worth far more to shareholders.
Given the earlier troubles of Toys "R" Us having been blamed on industry structure and practices, Berman is right on target to wonder why that would have changed. And why new, public investors would be any better off, over time.
In fact, this is the key point. A point with which I struggled for years, before my research confirmed my suspicions.
Buying an equity right after someone else has extracted huge value from restructuring is asking for trouble. If a management has managed for maximum shareholder gain, as the Toys "R" Us management surely has done for is private equity owners, why would you believe there is continuing value creation left?
If there were, why would KKR and its co-owners be selling all of Toys "R" Us?
It's rather like buying the Goldman Sachs IPO. Why would you buy equity when the smartest guys in the room are selling from their private supply of the stuff?
That's essentially what is occurring with Toys "R" Us. Everyone who has been associated with the failed toy firm from its purchase by the private equity group, until now, has likely been compensated on the IPO price.
Not an equity price of the firm five years from now.
Berman is correct to note the immense risk that any new Toys "R" Us shareholders run in buying the IPO. They won't have the leverage which KKR & Co. had when they owned the failed company. Worse, they'll be buying after the largest value extraction at Toys "R" Us in something like a decade.
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