As Toys ‘R’ Us heads for liquidation, a common refrain has it that the toy retailer failed to successfully reorganize in Chapter 11 because it took on too much debt. The 2005 leveraged buyout (LBO) of Toys ‘R’ Us by a group of investors led by KKR Group, Bain Capital, and Vornado Realty Trust is a particular target for blame. But this ignores the larger issue, of which the LBO and the subsequent bankruptcy are merely symptoms. In short, Toys ‘R’ Us collapsed, like many companies have, because of a failure to innovate.
Unmanageable debt and capital structures – though primary motivations behind Chapter 11 reorganization attempts – are rarely the cause or the explanation of a failed Chapter 11 reorganization attempt. The reason is simple: The financial distress associated with debt can usually be dealt with through the reorganization process. Chapter 11 is a tool for firms to shed onerous debt and adopt new capital structures that are better suited to their business model. On the other hand, bankruptcy law does not cure economic failings, and the weaknesses of a bad business model can be difficult to overcome by the time a company reaches bankruptcy. The inability to respond to technological disruption in a timely fashion has devastated not just Toys ‘R’ Us, but other big name companies such as RadioShack, Kodak, Borders Bookstore, and Blockbuster.
The recent history of once-proud companies at the top of their fields falling into liquidation for failing to respond to a changing market is detailed in Technically Bankrupt, by Brook Gotberg. Like Toys ‘R’ Us, Borders and Blockbuster used business models that relied on a public that would purchase items in a brick-and-mortar storefront rather than ordering online. As public preference for online shopping shifted, these companies failed to keep up, continuing to pour resources into the maintenance of expensive real estate. Despite the early cooperation of lenders and the best intentions for a sale of assets as a going concern, management was unable to change their business models in time to salvage corporate going-concern value, and liquidation became the only option.
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