Can Debt-Laden Toys R Us Survive After FAO Purchase?

Turning around the high-end toy business is far from child's play.

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Stephan Savoia

Yet last night, debt-laden Toys R Us thrust itself into the high-end toy business by purchasing struggling toy chain FAO Schwarz. The two toy chains are surviving thanks in part to the financial backing of three prominent private equity firms.

It isn't clear just whether Toys R Us paid more or less than the $41 million dollars firm D.E. Shaw paid back in 2003 to buyout FAO Schwarz out of bankruptcy. The terms of the deal itself have not been disclosed.

What is known is that the three firms who own debt-laden Toys R Us certainly do have deep pockets.

Vornado Realty Trust , the largest publicly traded office landlord in the U.S. by market capitalization, has owned a third of Toys R Us since 2005. It joined forces with firms Bain Capital and KKR to buy the bankrupt toy store for $6.6 billion dollars at the height of the private equity boom.

Now those three firms are leaping into the high-end toy business during a recession.

Critics question whether financial innovators can succeed as merchants since the retail business can often be more of an art than a science. Consumers make purchases based on emotion and not solely on product price tags.

Perhaps the fate depends on whether those big p.e. dollars also pay top dollar to bring in retail executives to run the merchandising side of things.

Toys R US CEO Gerald Storch has had some success in increasing sales and heightening the profile of the toy company in recent years.

Toys R Us will now gain FAO's flagship New York City location in the famed General Motors building, a Las Vegas location and all of its online and catalog businesses.

Storch says the acquisition of FAO Schwarz "allows us to grow our toy specialist market share and draw upon the unique strengths of both brands in developing quality products that differentiate us from our mass market competitors." In other words, the value of the acquisition is that the two can compete together against Wal-Mart .

Toys R Us' gain comes at a slight loss for department store Macy's . The acquisition nixes a year-old agreement to build FAO Schwarz boutiques inside more than 600 Macy's locations. The more than 200 existing locations will be closed by November.