NEW YORK--(BUSINESS WIRE)--
Fitch Ratings has downgraded the issue ratings on Toys 'R' Us, Inc.'s
(Toys, HoldCo) $450 million 10.375% senior unsecured notes due August
2017 and $400 million 7.375% senior unsecured notes due October 2018 to
'CCC-/RR5' from 'CCC/RR4'. Fitch has also affirmed the Issuer Default
Ratings (IDRs) on Toys 'R' Us, Inc. and its various domestic
subsidiaries at 'CCC'. A full list of rating actions follows at the end
of this press release.
Toys has provided better clarity in its recent 8-K filing dated June 18,
2014 related to its intercompany loans between HoldCo and Toys 'R'
Us-Delaware, Inc. (Toys-Delaware). These include $783 million in
long-term notes payable to Toys-Delaware by HoldCo and $316 million in
short-term loans due from Toys-Delaware to HoldCo as of Feb. 1, 2014.
Previously, Toys-Delaware only disclosed $777 million of intercompany
receivables due from HoldCo and affiliates as of Feb. 1, 2014, which
included $265 million of long-term loans made to HoldCo in 2012. The
nature of these long-term loans as well as the remaining payable from
HoldCo to Delaware was not disclosed.
In its recent 8-K, Toys disclosed that HoldCo had issued $783 million of
notes due to Delaware between 2005 and 2012 - and that all of the notes
are documented, unsecured and include a market rate of interest. In
addition, Toys stated that the $206 million notes issued in FY 2012 are
expressly subordinated in right of payment to the senior obligations of
Holdco, which implies that the remaining $577 million are pari passu
with the $850 million HoldCo notes. Therefore, any recovery value
allocated to these public bonds would now need to be prorated with the
$577 million senior notes due to Toys-Delaware.
While Toys-Delaware has $316 million short-term loans due to HoldCo,
Fitch does not assume HoldCo can effectuate a setoff against their
long-term obligation to Toys-Delaware. The short-term unsecured loans at
Toys-Delaware are used to fund seasonal working capital needs and
therefore considered unsecured claims that rank below all the secured
debt at Toys-Delaware. In addition, Fitch does not believe that HoldCo
can net these current assets against their debt due to Toys-Delaware
because any liquidation proceeds from the HoldCo assets would need to
pay down both the $850 million HoldCo notes and the $577 million notes
due to Toys-Delaware on a pro rata basis.
KEY RATING DRIVERS
Fitch's ratings on Toys reflects the company's deteriorating top-line
and EBITDA trends, increasing risk of market share loss and weakening
While Toys reported comparable store sales (comps) growth at 4% and 1%
in first quarter 2014 for its domestic and international segments,
respectively, Fitch believes these were due to easy comparisons with the
comps of negative 8.4% and negatively 5.8% in first quarter 2013. Fitch
expects Toys' comps will remain under pressure declining by low single
digits for its domestic and international segments in the next 12-18
months. The company has seen sales decline in its major categories such
as juvenile (approximately 30% of Toys' total sales) and sustained
weakness in the entertainment category (11% of total sales) due to low
birth rates and secular pressure.
The company faces intensified pricing competition from both discount and
online retailers. Despite Toys' multichannel strategy and series of
product and service initiatives, Fitch believes it will be expensive and
difficult for Toys to compete on pricing and retain its market share
without sacrificing margins.
Fitch estimates that Toys would need to stabilize sales and modestly
improve its gross margin to generate adequate EBITDA at the $650 million
level to cover annual interest expense assumed at $360 million, capex of
$250 million and modest cash taxes. However, achieving this level is
likely challenging without significantly lowering its cost structure and
controlling inventory levels. Fitch expects 2014 EBITDA to be in the
$450 million-$500 million range, assuming a low/single digit comps
decline and gross margin decline of 20 bps-50 bps. Fitch expects limited
reduction of SG&A expense in the near term as the company is committed
to allocating the modest cost savings toward further investments in its
online strategy and improving store presentation and service.
Fitch expects leverage (adjusted debt/EBITDAR) to increase to the 9x
level and FCF to be negative $250 million, excluding significant working
capital swings in 2014 and 2015. Availability under the ABL revolver
during peak working capital season is expected to be around $700 million
in 2014 and $500 million in 2015. This indicates adequate liquidity for
the next 18 months but liquidity concerns increase in 2016 given more
than $1 billion of debt maturities.
RECOVERY ANALYSIS AND CONSIDERATIONS
Fitch has conducted a recovery analysis across Toys' organizational
structure to determine expected recoveries in a distressed scenario to
each of the company's debt issues and loans. Toys' debt is at three
types of entities: operating companies (OpCo); property companies
(PropCo); and HoldCo, with a summary structure highlighted below.
Toys 'R' Us, Inc. (HoldCo)
(I) Toys 'R' Us-Delaware, Inc. (Toys-Delaware) is a subsidiary of HoldCo.
(a) Toys 'R' Us Canada (Toys-Canada) is a subsidiary of Toys-Delaware.
(b) Toys 'R' Us Property Co.II, LLC is a subsidiary of Toys-Delaware.
(II) Toys 'R' Us Property Co.I, LLC is a subsidiary of HoldCo.
Fitch has assigned a 5.0x-5.5x multiple to the stressed EBITDA at the
OpCo levels - Toys-Delaware and Toys-Canada - which is consistent with
the low end of the 10-year valuation for the public space and Fitch's
average distressed multiple across the retail portfolio. The stressed EV
is adjusted for 10% administrative claims.
Toys has a $1.85 billion asset-based revolving credit facility (ABL
revolver) with Toys-Delaware as the lead borrower, and this contains a
$200 million sub-facility in favor of Canadian borrowers. Any assets of
the Canadian borrower and its subsidiaries secure only the Canadian
liabilities. The $200 million sub-facility is more than adequately
covered by the EV calculated based on stressed EBITDA at the Canadian
subsidiary. Therefore, the fully recovered sub-facility is reflected in
the recovery of the consolidated $1.85 billion revolver discussed below.
The residual value is applied toward debt at Toys-Delaware.
At the Delaware level, the recovery on the various debt tranches is
based on the liquidation value of the assets estimated at $2.1 billion,
approximately $115 million recovery against the $577 million of
intercompany loans to HoldCo, and the equity residual from Canada
estimated at $210 million.
The $1.85 billion revolver is secured by a first lien on inventory and
receivables of Toys-Delaware. In allocating an appropriate recovery,
Fitch has considered the liquidation value of domestic inventory and
receivables assumed at seasonal peak (at the end of the third quarter),
and has applied advance rates of 75% and 80%, respectively. Fitch
currently assumes $1.3 billion (or approximately 70% of the facility
commitment) drawn under the revolver at the peak season in 2015 based on
Fitch's projections of EBITDA and liquidity needs. The facility is fully
recovered and is therefore rated 'B/RR1'.
The recovery value of the debt structure below the first lien revolver
is derived from three components: (1) excess liquidation value at the
Toys-Delaware level (liquidation value after the full recovery of ABL
revolver); (2) estimated value for Toys' trademarks and intellectual
property assets (IP, which are held at Geoffrey, LLC (IPCo) as a wholly
owned subsidiary of Toys-Delaware); and (3) equity residual value from
Canada. Components (1) and (2) are fully applied toward the senior
secured term loans and 7.375% secured notes, while 3) is applied across
the capital structure.
The $1.24 billion term loans due 2016 and 2018 and the $350 million
senior secured notes due 2016 are secured by a first lien on the IP and
a second lien on the ABL revolver collateral. They are assumed to have
recovery prospects of 51%-70%, which reflects excess value from the
credit facility collateral as well as some modest valuation of the IP
assets, and are therefore rated 'CCC+/RR3'.
The 8.75% debentures due Sept. 1, 2021, have poor recovery prospects and
are therefore rated 'CC/RR6'.
At the PropCo levels - Toys 'R' Us Property Co.I, LLC; Toys 'R' Us
Property Co.II, LLC; and other international PropCos - LTM NOI is
stressed at 20%.
PropCo I and PropCo II are set up as bankruptcy-remote entities with a
20-year master lease through 2029 covering all the properties, which
requires Toys-Delaware to pay all costs and expenses related to leasing
these properties from these two entities. The ratings on the PropCo debt
reflect a distressed capitalization rate of 12% applied to the NOI of
the properties to determine a going-concern valuation. The stressed
rates reflect downtime and capital costs that would need to be incurred
to re-tenant the space.
Applying these assumptions to the $725 million 8.50% senior secured
notes at PropCo II and the $985 million senior unsecured term loan
facility at PropCo I results in recovery well in excess of 90%.
Therefore, these facilities are rated 'B/RR1'.
The PropCo II notes are secured by 125 properties. The PropCo I
unsecured term loan facility benefits from a negative pledge on all
PropCo I real estate assets (343 properties as of May 4, 2013). Fitch
typically limits the Recovery Rating on unsecured debt at 'RR2' or two
notches above the IDR level (under its criteria 'Recovery Ratings and
Notching Criteria for Non-financial Corporate Issuers' dated Nov. 20,
2013). However, in the few instances where the recovery waterfall
suggests an 'RR1' rating and such a Recovery Rating is supported by the
structural and legal characteristics of the debt, unsecured debt may
qualify for an 'RR1' rating. In addition, the rating also benefits from
the structural consideration that Toys 'R' Us has limited capacity to
secure debt using real estate given that there is a limitation on
principal property of domestic subsidiaries at 10% of consolidated net
tangible assets under the $400 million of 7.375% notes due 2018 issued
Toys 'R' Us, Inc. - HoldCo Debt
The $450 million 10.375% unsecured notes due Aug. 15, 2017, and the $400
million 7.375% unsecured notes due Oct. 15, 2018, benefit from the
residual value at PropCo I, currently estimated at approximately $300
million. There is no residual value ascribed from Toys-Delaware or other
operating subsidiaries. Prorating the residual value against the $577
million senior notes due to Toys-Delaware that are considered pari passu
with the publicly traded HoldCo notes translates into below-average
recovery prospects of 11%-30% for the bonds which are therefore rated
A negative rating action could result if comps trends in the U.S. and
international businesses continue to be in the negative 4%-negative 5%
range and/or gross margins decline by similar rates to 2013 without any
offset from cost reductions. This would indicate more severe market
share losses and lead to tighter liquidity than Fitch's current
expectation over the next 18 months.
A positive rating action could result if there is sustainable
improvement in Toys' store and online traffic, indicating improved
market share positioning, and meaningful cost restructuring. Toys would
need to drive EBITDA improvement to a level where it can meet fixed
obligations and fund any working capital swings, and manage refinancing
of upcoming debt maturities on a timely basis.
Fitch has affirmed the following ratings except for downgrading the
issue rating of the HoldCo notes as follows:
Toys 'R' Us, Inc. (HoldCo)
--IDR at 'CCC';
--Senior unsecured notes downgraded to 'CCC-/RR5' from 'CCC/RR4'.
Toys 'R' Us - Delaware, Inc. is a subsidiary of HoldCo
--IDR at 'CCC';
--Secured revolver at 'B/RR1';
--Secured term loans at 'CCC+/RR3';
--Senior secured notes at 'CCC+/RR3';
--Senior unsecured notes at 'CC/RR6'.
Toys 'R' Us Property Co.II, LLC is subsidiary of Toys 'R' Us -Delaware,
--IDR at 'CCC';
--Senior secured notes at 'B/RR1'.
Toys 'R' Us Property Co.I, LLC is a subsidiary of HoldCo
--IDR at 'CCC';
--Senior unsecured term Loan facility at 'B/RR1'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Recovery Ratings and Notching Criteria for Nonfinancial Corporate
Issuers' (Nov. 20, 2013);
--'Recovery Rating and Notching Criteria for Equity REITs' (Nov. 19,
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage
Recovery Ratings and Notching Criteria for Non-Financial Corporate
Recovery Ratings and Notching Criteria for Equity REITs
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Source: Fitch Ratings