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Toys R Us instigates UK CVA

By Paul Norman - Monday, December 04, 2017 9:54

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Toys R Us this morning announced plans for a Company Voluntary Arrangement (CVA) that will likely see around 26 of its 105 UK stores closed.

In a statement Toys R Us UK said it was announcing a plan to “transform the business to meet the evolving needs of customers in today’s UK retail market. By instigating a Company Voluntary Arrangement (CVA), the company will seek creditor approval to reposition its real estate portfolio for future growth and profitability”.

It added: “There will be no disruption for customers shopping through the Christmas and New Year period. During 2018, the proposed plan will entail changes to the store estate as it moves to a new and exciting business model.”

Steve Knights, Managing Director of Toys R Us UK, said: “All of our stores across the UK remain open for business as normal through Christmas and well into the New Year. Customers can also continue to shop online and there will be no changes to our returns policies or gift cards across this period.

“Like many UK retailers in today’s market environment, we need to transform our business so that we have a platform that can better meet customers’ evolving needs. The decision to propose this CVA was a difficult one, but we determined it is the best path forward to make essential changes to the business.

“Our newer, smaller, more interactive stores are in the right shopping locations and are trading well, while our new website has generated significant growth in online and click-and-collect sales. But the warehouse style stores we opened in the 1980’s and 1990’s, while successful in the early days, are too big and expensive to run in the current retail environment. The business has been lossmaking in recent years and so we need to take strong and decisive action to accelerate the transformation.”

Under the CVA process, Toys R Us UK has submitted a “comprehensive operational and financial restructuring plan to its creditors and will solicit their approval of this plan over the next 17 days”.

If approved by the creditors, the CVA plan would substantially reduce the UK company’s rental obligations and allow the business to move to a "new, viable business model". The process is likely to involve the closure of at least 26 stores. The company intends to commence store closures in Spring 2018.

The business employs 3,200 people, and as part of the CVA process, it anticipates a requirement to make redundancies. “All efforts will be made to redeploy team members where possible”.

Knights added: “We recognise this process will affect many of our team members and their families, so we are committed to keeping all of our staff informed throughout this process. Our teams will continue to play a key role in turning our business around.”

A detailed CVA proposal document (with voting procedures) will be made available to creditors securely via a dedicated website page today at: and other interested parties will be able to access the proposal at: from Tuesday 5th December 2017. The creditors will vote on the CVA on 21 December 2017.

Alvarez & Marsal is serving as restructuring advisor to Toys R Us UK and Kirkland & Ellis is serving as principal legal counsel to the company. Over the coming days, the company will hold talks with creditors to ensure they understand the full detail of the proposal.

The closures would form part of a deal to renegotiate debts owed by the company to its landlords - which must be agreed by 75% of its creditors.

The CVA process is separate to bankruptcy protection proceedings involving Toys R Us's US parent company, which were announced in September.

Confirmation in September that Toys R Us, the famous toy retailer with 1,600 stores in 38 countries, had filed for bankruptcy sparked renewed questions about the health of bricks and mortar retailers in the internet age, and in turn has implications for billions of pounds of CMBS loans exposed to Toys “R” US or Babies “R” US stores including 2013’s £263m UK Toys “R” US CMBS.

In September Toys R Us said that while it had filed for Chapter 11 bankruptcy, the majority of its stores remain profitable and it has secured a new $3.1bn operating loan from a JP Morgan Chase & Co-led syndicate which, subject to court approval, it will invest in stabilising operations, refreshing stores and reopening supply channels, all of which mean it does not plan to close stores.

It also confirmed its locations across the globe including the UK were not affected by the bankruptcy.

Toys R Us’s filing did confirm that the company had in excess of $5bn in debt, which it pays around $400m a year servicing – a legacy in the main of Bain Capital, KKR & Co. and Vornado Realty Trust’s leveraged 2005 buy out of the group.

Toys R Us said press speculation about a potential bankruptcy earlier in the year caused difficulties with its vendors that hit business operations and led to the filing.

Despite Toys R Us’s bullish position on its stores portfolio, the filing once again turned the spotlight on the businesses of traditional bricks and mortar retailers and will no doubt be causing bondholders in a number of CMBS vehicles exposed to Toys R Us’s stores to review options.

The toy sector, where goods are typically bulky and inexpensive, is thought to be particularly exposed to the world of online next day delivery competition and in particular Amazon's success.

In the US, Treppwire has reported that CMBS loans that feature Toys “R” Us or Babies “R” Us as one of the five largest tenants comprise 109 outstanding loans totalling about $5.5bn with some Toys “R” Us exposure.

However, last year's restructuring of the debt of the US arm of Toys R Us, which involved a mixture of funding at various company levels, stands aside from that of the UK business which is externally funded in particular at the property company level via the £263m sale and leaseback Debussy CMBS.

In July 2013 Toys R Us priced and closed the securitisation of 31 UK-wide retail stores and a distribution centre, as PIMCO and Marathon Asset Management converted their £263.16m bridge loan into seven-year Debussy DTC CMBS notes at par.

CoStar News reported that PIMCO had acquired the entire £184.2m class As and £52.6m class Bs, while Marathon had taken the majority of the £26.3m class Cs – all less a vertical 5% retention by Toys R Us, in compliance with the post-crisis EU 5% Capital Requirements Directive (CRD) for banks and investment firms.

Toys R Us, jointly-owned by Bain Capital Partners, Kohlberg Kravis Roberts & Co and Vornado Realty Trust, had refinanced the Vanwall Finance CMBS on 28 March and that converted at the fixed rates: 5.93% for the class As; 8.25% for the class Bs and; 10.5% for the class Cs.

Debussy CMBS was the first non-bank structured European CMBS, arranged by Cairn Capital, agreed between capital market investors, PIMCO and Marathon, and the borrower Toys R Us direct, with no bank in the middle. It was also the first European CMBS which, at issuance, did not include a AAA tranche, with the secondary quality of the portfolio such that the most senior rating was A-, by Standard & Poor’s, and BBB-low, by DBRS.

At the time, Situs, which was appointed servicer and special servicer, said the transaction represented the first secondary commercial property portfolio to return to European securitisation markets since the global financial crisis and suggested it could kick-start the financing of other challenging asset classes, and showed an evident recovery in the European securitisation markets.

The 1.87m sq ft Toys R Us portfolio was of secondary quality, owned within an opco-propco structure delivering an annual passing rent of £23.0m, comprising 30 retail stores and a distribution centre in Coventry collectively valued at £315m, according to the 2013 20 March-dated valuation by CBRE. The vacant possession value was 38% lower, at £194.51m.

The Coventry distribution centre was the highest valued asset, at £42.5m, with the remaining portfolio valued at between £3.2m and £17.5m.

Every asset had a 30-year occupational lease, maturing in February 2036, except one lease which expired February 2037. All leases were subject to five-yearly upward-only rent reviews.

The Debussy CMBS matures in July 2020, with a five-year tail period to the legal final maturity in July 2025. Beneath the CMBS were £80.2m in subordinated intercompany loans.

While Toys R Us has confirmed the UK business is not affected by the US bankruptcy filing, experts have suggested bondholders will be focused on various options to ensure the best outcome.

These will likely review the potential to sell the portfolio or to hold and work up a business plan for finding alternative uses for individual assets.

CMBS experts today suggested it is "statistically unlikely that Debussy won’t be significantly affected" by the CVA but possible. 

In its most recent update on the CMBS structure in July of last year Deutsche Bank analysts were negative on all notes in Debussy, considering that even the Class A will ultimately be vulnerable to losses in the region of 6%.

It wrote: “While the reported EBITDAR (R for rent) to Rent ratio in 2015 of 2.34x looks healthy (stripping out the royalty payments to the US parent would add c 35ppts to this figure), we think this does not reflect the broader picture. Looking closely at the consolidated (ie OpCo and PropCo) accounts of the UK entity, we see that trading performance has declined to the extent intercompany interest transfers are the predominant source of profits. Indeed, it is our calculation that without these the CMBS interest payments would not have been covered by earnings (excluding non cash charges and adding back royalty payments to the parent) in 2013, and in 2014 are only covered 1.16x.

“We are of the view that only minor solace can be taken from any recourse to the underlying property – predominantly out of town solus units, with one fifth subject to planning restrictions. While our estimate of Vacant Possession Value today is similar to that of the April 2016 valuation, and implies a 53% recovery at the Class B, we think the structural outlook for many of these units over the coming years will be negative, and there is potential for a slide in values of circa 20% in the four years to the 2020 loan maturity.

“This is due to many of the forces impacting large sectors of physical retailing – namely growth to online shopping in the non-food sector. The risk of cyclical moves amplifying these factors must also be acknowledged - our colleagues in Economics Research reduced their economic forecasts for 2017 GDP growth in the UK downwards by 1.2ppts to 0.9%, following the recent referendum.

“While we think the loan is likely to continue paying interest until maturity in 2020, the scale of sectoral decline makes a loss at the Class A level a distinct possibility should the intercompany support be discontinued – the continuance of which we do not think should be taken as a given following the recent US restructure, and also if a more online oriented business model is pursued.”

Updating on Debussy in September following the US bankruptcy filing and the posting of further accounts Deutsche was more negative.

It said: "According to our understanding of the accounts of the OpCo (Toys R Us Holdings Ltd) filed at UK Companies House, the UK arm has significant reliance on intercompany funding - we think any elimination would place significant pressures on payment of loan interest on Debussy, even aside from impacts of the various headwinds in 2017/18 impacting retailers across the UK (business rates, minimum wage, utilities, erratic consumer spending etc).

"In this respect though we were negative in our earlier July 2016 analysis, we thought the loan would remain current until 2020 maturity, we now wonder if we were not negative enough at the time, thinking there are now significant risks the loan will enter Special Servicing in 2018."

Risk wise Deutsche added: "Risk factors include continued weak trading of the underlying UK OpCo, weak performance of marginal solus units, potentially amplified by any cyclical factors affecting the wider UK economy.

"We also note any strategy to build a significant online presence, as in the US, would risk cannibalising trading at physical locations, adding to risks of PropCo level debt. Similar to this, any attempt to reduce general overheads through the closure of stores would also be negative for PropCo debt. Upside would come from continued intercompany support to the OpCo allowing a refinancing of the debt or - potentially to the Bs and Cs - any eventual restructure giving alternate consideration, such as OpCo equity."

In an Irish Stock Exchange update today Situs Asset Management, as special servicer to Debussy DTC, said: "The Servicer has informed the Issuer that Toys"R"Us UK has instigated a Company Voluntary Arrangement: Further updates will be provided by the Servicer to the Noteholders in due course."

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