Toys R Us, Babies R Us to try side-by-side stores

When a buyout group that included Vornado Realty Trust bought Toys R Us Inc. in 2005, analysts suspected the new owners would sell off the bruised retailer's valuable real estate and get out of the toy business.

Nearly three years later, Toys R Us is instead in an expansion mode, buoyed by rising sales and profits and a new strategy for boosting foot traffic: putting its toy stores in buildings side-by-side with outlets of Babies R Us, the company's growing infant-products chain.

“There's nothing I've ever done in my career that remotely approximates liquidating a company,” Gerald Storch, the company's chairman and chief executive, said in an interview.

Storch, the 52-year-old former vice chairman of Target Corp., said Toys R Us will open 16 of the side-by-side superstores this year, each with combined retail space of 60,000 square feet to 70,000 square feet. The company also will convert dozens of existing toy stores into smaller side-by-side locations this year, and within a few years will turn the rest of its 585 U.S. outlets into this format or build new superstores, Storch added.

Suddenly, the world seems safe again for toy retailers. Last week, Macy's Inc. said it will open FAO Schwarz toy boutiques in 685 of its stores. That represents the first major build out of the brand since hedge fund D.E. Shaw & Co. bought FAO Schwarz in 2004.

Toys R Us and FAO Schwarz both fell victim to the ever-increasing speed at which children are outgrowing more traditional toys in favor of electronic devices. The chains also were hammered by the discounting of Wal-Mart Stores Inc., which became the biggest toy seller a decade ago and now commands 25 percent of the market.

Storch – hired in 2006 by owners Vornado, Bain Capital Partners LLC and Kohlberg Kravis Roberts & Co. – has emphasized sales of more electronic and entertainment products at Toys R Us, while expanding the company's reach abroad. He derides the idea that specialty players can't compete with discounters as “victim talk,” naming CVS Caremark Corp., Best Buy Inc. and Bed Bath & Beyond Inc. as “a few that are proving that theory wrong.”

In the year ended Feb. 2, Toys R Us earned $153 million, up 40 percent from a year earlier. Sales climbed 5.7 percent to $13.8 billion. It was the second consecutive year of increases. Sales at U.S. stores open a year or more gained 2.2percent, while toy sales fell industrywide.

Some analysts see the company going public within the next two years if it can keep up the gains. One issue is the need to deal with $5.8 billion in debt, a hangover of the buyout. Toys R Us says it will finance its store changes internally.

“What they've done is a tremendous achievement given the amount of debt they've been bogged down with, but I have my doubts about whether they can turn this thing around,” adds Howard Davidowitz, a retailing consultant in New York. He notes that Wal-Mart and Target are expanding more rapidly than Toys R Us, and “that's going to really hurt them.”

The side-by-side site strategy addresses a weakness that has handicapped the company in battling discounters. In the past, Toys R Us shoppers with children have visited an average of once every nine months, while Wal-Mart and Target have drawn these shoppers weekly with a broader array of goods, says Sean McGowan, an analyst for Needham & Co. in New York.

Toys R Us says that in its pilot side-by-side locations, moms visit Babies R Us stores almost monthly, and when they do, often visit Toys R Us for their other children.

Toys R Us has closed 86 toy stores in the past two years, and taken some profits from real-estate sales for its new owners. But over the period, it has boosted Babies R Us outlets by 30 to 260, and added 74 Toys R Us stores abroad, bringing the number of international toy stores to 715.