UPDATE: July 10, 2018: In a July 6 letter, Ken Mehlman, head of global public affairs for KKR, responded to Democratic lawmakers' inquiry regarding the buyout and failure of Toys R Us. Mehlman described Toys R Us as a "challenged business" when the firm, together with Bain Capital and Vornado Realty, acquired it in a 2005 leveraged buyout. Mehlman said KKR "lost many millions of dollars" in the buyout and did not want Toys R Us to liquidate in bankruptcy, "but the creditors had a different and prevailing view." Notably, he also said that KKR thinks it has "found a path outside of the bankruptcy process to help those [employees] who need it most," indicating the firm might support some form of severance pay for laid-off workers.

Dive Brief:

• U.S. lawmakers have contacted the executives of Toys R Us' private equity owners to question the firms over their financial practices in acquiring and running the toy retailer, which has been forced to liquidate in bankruptcy. Toys R Us did not immediately respond to a request for comment.
• In a letter signed by 18 Democratic House members and Senator Bernie Sanders, the lawmakers asked executives of Bain Capital, KKR and Vornado Realty — the group that bought Toys R Us in 2005 in a transaction that left billions of dollars in debt on the retailer's books — to justify transforming the retailer's capital structure from 30% debt to 78% debt.
• Additionally, the lawmakers asked about what they say were $470 million in "unspecified fees and interest payments" paid by Toys R Us to its owners. They also wanted to know whether the firms planned to pay severance to Toys R Us employees laid off in the liquidation and whether anyone associated with the firms were involved in the decision to layoff employees. The lawmakers have asked the firms to respond by July 15.

Dive Insight:

Scrutiny of private equity ownership is increasing as the ranks of private-equity owned retailers filing for bankruptcy increases.

In a January paper published with the American Bankruptcy Institute, Chuck Carroll and John Yozzo of FTI Consulting found that two-thirds of retail bankruptcy filings in 2016 and 2017 were by private equity-controlled companies.

Two of the largest retail bankruptcies in 2018, Nine West and Claire's Stores, were also private equity owned companies, whose buyouts have been scrutinized by some stakeholders.

In the case of Toys R Us, the retailer for years underinvested in people, systems, stores and other areas crucial to the company's survival as it grappled with annual interest costs in the hundreds of millions of dollars.

The combination of high debt, and high interest payments that go along with it, with a low-margin business such as retail may be especially dangerous. Carroll and Yozzo found that retailers that have been through leveraged buyouts in private equity takeover accounted for 17% of Chapter 11 filings in retail over the previous six years, as compared to 9% for all industries. Analysts with S&P Global have warned that other leveraged buyouts in retail could lead to more defaults in 2018.

Long before Congressional leaders scrutinized Toys R Us' payments to its private equity owners, unsecured lenders to the retailer opened up an investigation into the matter, a common tactic for unsecured creditors in a bankruptcy case. Those stakeholders found that Toys R Us paid more than $100 million in advisory fees and lease payments to its owners in the five years leading up to bankruptcy. But the number since 2005 is much larger, including annual fees as large as $21 million in prior years and a $81 million payment on closing the transaction, according to regulatory filings. In cases where sponsors bought Toys R Us debt, the retailer has also paid interest to its owners.

Whatever damage might be traced to the buyout is done. More than 30,000 Toys R Us employees are now facing unemployment. Some of them are fighting for severance, and they have successfully enlisted politicians to help them in the fight, as the Democratic letter shows. As one of those longtime employees, Maryjane Williams, told Retail Dive earlier this summer: "When these big companies buy out retailers, walk away with what they're walking away with — I built this company. I helped build it."

"My severance was to work for the liquidator for the next 60 days," she added. "I'm still walking away with nothing."