Toys ’R’ Us preps bond to takeout CMBS Giraffe; potential IPO in the wings, sources say

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Toys “R” Us is preparing to issue new secured bonds to address the massive overhang of USD 800m in CMBS debt that comes due in August 2010, four bond holders and two sellside analysts told Debtwire. Bank of America and Deutsche Bank arranged the CMBS issues in 2005 during Toys’ LBO and are rumored to be preparing to launch the refinancing as early as this week, according to multiple sources.

The mortgages on the properties in question continue to perform well, but with CMBS markets in deep freeze, refinancing the debt that way is not an option. The giant toy retailer can’t join the amend and extend fad sweeping leveraged loan markets either because of the nightmarish logistics – unanimous bond holder approval – needed to change payment terms of CMBS.

Compare those headaches to the relatively free money flooding into high yield and Toys’ decision to take out the structured debt with new bonds secured by the same assets looks like a no-brainer. Add in the fact that Toys easily refinanced a real estate-backed loan with new secured bonds in August and it starts to look like a slam dunk.

The only hitch: paying back CMBS bonds early is a lot harder than taking out syndicated loans.

When Deutsche and BofA underwrote the CMBS debt to help back Toys’ USD 6.6bn buyout, they repackaged it into larger bonds sold to insurance companies, pension funds and assorted asset managers. Those investors, particularly the insurers, insisted on structures that punish prepayment because they want to hold on to assets as long as possible to offset their liabilities.

Nevertheless, that’s exactly what Toys’ private equity sponsors – Kohlberg Kravis Roberts & Co. (KKR), Bain Capital Partners and Vornado Realty – plan to do. Part of their haste reflects uncertainty about how long the junk bond market will remain open, but it also jibes with their strategy to clean up Toys’ balance sheet ahead of an IPO.

In June 2008, Toys “R” Us inked a reorganization to simplify its corporate structure that points toward an IPO process, said a bond holder. The company has been hitting all its performance targets so it makes sense for the sponsors to seek a return within four to five years, he added.

KKR recently monetized exposure to another retailer in its portfolio, Dollar General, through a USD 750m IPO. Toys could fetch a 7x-8x EBITDA multiple in equity markets based on where other big box retailers such as Pet Smart, Best Buy, Bed Bath and Beyond and Staples trade, said a sellside analyst.

An IPO for Toys could fetch anywhere between USD 750m-USD 1bn, the analyst estimated. As of 1 August, LTM EBITDA was USD 947m. The sponsors contributed USD 1.2m of equity when they purchased the company, according to SEC documents

Not as easy as it looks

Back in 2005, Toys’ USD 800m deal exceeded even the largest of CMBS offerings of the times, and the two underwriters sliced the debt a number of ways to find it a home. First they split it into a USD 600m portfolio through a property company called Giraffe Properties and a USD 200m piece secured issued out of a separate propco called MBO Properties.

Deutsche and BofA then divided the Giraffe debt into USD 425m of senior notes and USD 175m of mezzanine paper and the MBO debt into a USD 145m senior piece and USD 55m of mezz. Deutsche placed USD 255m of Giraffes’ senior debt and USD 87m of MBO’s into a trust, while BofA took USD 170m of Giraffe’s senior debt and USD 58m of MBO’s.

The two banks syndicated the mezz directly to investors but were forced to repackage the senior debt into larger CMBS vehicles to meet the diversification requirements of institutional investors. That paved the way for Toys’ current paydown dilemma

As long as Toys pays down all of its CMBS debt at once, it doesn’t need bond holder approval, but it does need signoff from the multiple servicers of the notes. The servicers in turn must contact the largest bond holders to informally obtain their approval.

That’s not a straightforward proposition in the case of the CMBS structures the Giraffe and MBO notes were packaged into because Toys’ assets comprised some of the best of breed in the deals’ respective collateral packages.

In January, Fitch downgraded the Bank of America CMBS deal that includes Toys’ notes due to a decline in performance of loans making up 16.7% of the trust, according to a ratings release. In contrast, the Toys-related debt in the package has performed well in both deals.

At the time of the downgrade, Fitch stated the Toys “loan has experienced stable performance and occupancy has not changed since issuance.” The underlying mortgages continued to perform throughout the year, said a source familiar with the deal.

In order to execute the early paydown of its CMBS, Toys would have had to reach out months ago to its notoriously slow moving servicers to get them on board, said three lawyers specializing in CMBS. The company has been working with lawyers on the matter, said a second sellside analyst and a second bond holder.

Toys could hit the bond market to refinance the CMBS within a matter of days, said all of the sources. Its USD 500m 7.625% senior holdco notes due 2011 were bid yesterday at 100.5 to yield 7.3% versus 101.125 on 27 October, according to MarketAxess. Five year CDS moved out a point yesterday to 11.5 points upfront, according to a buysider.

Toys did not return calls seeking comment. Bank of America Wachovia declined to comment and Deutsche Bank did not return calls. KKR declined to comment while Bain and Vornado did not immediately return requests for comment.

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