Jun 26, 2018

Toys "R" Us employees seek severance from private equity

Photo by Spencer Platt/Getty Images

Should the former private equity owners of Toys "R" Us pay around $70 million in severance to the company's 33,000 laid-off employees?

Why it matters: This is not an academic question. It's been debated by big public pension funds that invest in private equity, prompted by a lobbying campaign by left-leaning nonprofit advocacy groups.

  • The basic argument: Bain Capital, KKR and Vornado killed Toys "R" Us by saddling it with too much debt, while taking out fees along the way. It's only fair that they help folks who are without work because of private equity's mismanagement, particularly when PE firms are so rich and many of the employees were living paycheck-to-paycheck.
  • The legal argument: There is none. The private equity firms no longer own Toys "R" Us, and a bankruptcy court judge threw out the severance package because employees weren't high enough in the creditor stack.

This issue is far more complex than the pro-severance forces are making it out to be.

For starters, the private equity firms didn't favor liquidation. They wanted to engage with one of several offers that would have kept many of the U.S. stores operational, but a small group of creditors felt differently (and by that point had control). There is no push to demand severance from those creditors, even though some of them have public pension money themselves and will make money on Toys once all is said and done.

Second, there are many others who lost out on Toys "R" Us, including small toy-makers who are above workers in the payback pile, but who are unlikely to see a penny.

Finally, the pro-severance folks are a bit liberal (no pun intended) with their math. They argue the PE firms took out $464 million, by adding up advisory fees ($185m), expenses ($8m), transaction fees ($128m) and interest on debt held by the sponsors ($143m).

  • Yes, we were first to point out how the general partners may have gotten back more than they put in. But some of those fees were shared with LPs — including the now-aghast public pensions — while the interest was held in collateralized debt obligations (CLOs) that had their own investors.
  • In other words, PE "profit" was much smaller than claimed (although, on the flip side, you could argue the firms collected management fees on Toys-related capital that ended up being set on fire... again, it's complicated).

But, but, but: Despite all of those quasi-mitigating factors, PE firms do have moral obligations to portfolio company employees. You break it, you own it (even if you technically broke it while owning it, which caused someone else to own it).

  • They have the money. KKR alone reported $365 million of economic net income in just the first quarter, which is more than five times the total severance request.
  • As for precedent, Toys-like situations (i.e., total liquidations) are relatively unusual, even in bankruptcy. For example, KKR's biggest-ever bet (TXU) went bust but it didn't result in everyone losing their jobs. Bain's iHeartRadio also went bankrupt, but remains operational.
  • There are still some slippery slope arguments and legal complications, but they pale in comparison to the existential threat faced by those who lost their jobs and have been unable to find new ones (if the PE firms choose to only focus on those folks, or on those who made below a certain income level, that's a legit discussion to have).

Bottom line: There is a very good argument that the PE firms should pay at least some of the severance, or figure out some other form of compensation. And I have a sense that they might. Not because of preening public pension staffers or legal obligations, but because it's the right thing to do. Sometimes it's just that simple.

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