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Did Toys 'R Us Deliver a Big Warning for Retail?

Monday, 1 Apr 2013 | 5:00 PM ET
Shopper at Toys "R" Us
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Shopper at Toys "R" Us

Toys 'R Us has decided not to offer their shares publicly, as they had initially planned. In a Friday press release, the nation's biggest toy seller said they were withdrawing their IPO "due to unfavorable market conditions, and the company's recently announced executive leadership transition." Specifically, the company had previously announced that CEO Gerald Storch will be stepping down.

But Friday also saw the company report miserable fourth-quarter earnings. Not only did company's net income slide 30 percent on a light drop in revenue, but U.S. sales dropped by two percent. And probably worst of all, same store sales plummeted 4.5 percent from the year prior.

So what went wrong for Toys 'R Us—and what do those terrible numbers tell us about brick and mortar retail as a whole?

Noted analyst Sean McGowan of Needham & Company points to two key problem: video games and babies.

"Video game sales have just been in free fall," McGowan said. "The whole industry faces the challenge of so many digital products. If you buy an Android tablet, that's not free, but it's a Trojan horse." In other words, a tablet allows access to a whole universe of free or near-free games.

The second problem is with the Toys 'R Us baby business, and that problem there has largely been a demographic one. "The birthrate peaked in 2007," McGowan observes, "and it has not really rebounded. And that's directly related to the economy, as people have put off having kids. And people who do have kids trade down—so instead of buying a $300 crib, for example, they'll buy the $100 crib."

Janney Capital Markets analyst David Strasser notes that the Toys 'R Us results are just one more bad data point. "It's indicative of a challenging retail environment," Strasser said. Across the entire space, "no one's really had a good quarter."

But Strasser does not see the Toys 'R Us numbers as a reason to get out of companies like Target or Wal-Mart. "One problem is that Toys 'R Us doesn't have the same traffic drivers that Target and Wal-Mart have," Strasser said, "such as food and necessary items."

Toys 'R Us, then, just happened to be the middle of a lot of bad trends.

"When they say they're not filing an IPO because of market conditions, that may be a bit of a euphemism," McGowan said. "Really, the owners probably thought they wouldn't get the valuation they had hoped for."

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