Business has been so tough for Toys R Us' in the past few years, it disclosed this week that toys may not be in its future.
For credit investors, the implications have not been good, as the company's credit rating has been repeatedly cut deeper into junk status as it has pledged to "enhance shareholder value" as part of its strategic review.
Fitch Ratings and Standard & Poor's this week said they may cut the retailer's rating further, with both rating it at their second highest junk level. Moody's Investors Service did not comment after Toys R Us released its statement on Wednesday but also has a negative outlook on the rating.
Analysts had a hard time finding a silver lining for bondholders as Toys R Us said it was pondering selling its global toy business and spinning off its profitable Babies R Us division.
All of the strategic thinking comes as a result of its failure to combat the threat from major discounters such as Wal-Mart Stores and Target Corp Toys R Us has posted more than three years of negative same store sales.
"This sounds like an admission of defeat in Toys R Us' valiant attempt to divert customers from the discounters," said Carol Levenson at independent research shop GimmeCredit earlier this week. Levenson said Toys R Us, which is looking at sharply cutting its operating expenses and capital to boost the cash flow of the toy business, was likely to use any proceeds from spinning off Babies R Us to give a gift to shareholders - possibly through a $500 million dividend.
If the company decides to sell real estate as well, Levenson said that proceeds would also be handed over to shareholders, leaving the company with its debt load, now at $2 billion. An analyst at Lehman Brothers valued Toys R Us' global holdings at $3.1 billion.
"You could always wait to see the actual spinoff figures, but barring the unlikely acquisition by a stronger credit, we don't envision things getting much better for bondholders," she said.
Certainly credit traders did not think much of Toys R Us' plan, driving its standard five-year spread in credit default swaps wider by roughly 50 basis points after the announcement Wednesday to trade around 320 basis points. That means it costs $320,000 costs a year for every $10 million of default protection.
But even with all the expectations for Toys R Us to shower its shareholders with any dough, its near-term credit risk remains pretty low. For one thing the company has $1.1 billion of cash on hand, though cash has declined. It will be free cash flow positive this year and has no significant amount of debt coming due until 2006.