Specialty toy retailers on ropes

A fragile economy, no hit toys, and a suddenly stingy investment community have sent several specialty toy retailers scrambling to try and keep afloat in recent weeks (see 'Specialty toy retailers' year of woe' below). Perhaps the biggest and most surprising...
May 1, 2001

A fragile economy, no hit toys, and a suddenly stingy investment community have sent several specialty toy retailers scrambling to try and keep afloat in recent weeks (see ‘Specialty toy retailers’ year of woe’ below). Perhaps the biggest and most surprising name to emerge clinging to life is King of Prussia, Pennsylvania-based Zany Brainy. At one point considered the stalwart of the sector, in early March, Zany revealed it had defaulted on a US$115-million line of credit loan from its main creditor First Union National Bank, which subsequently cancelled that loan, leaving the retailer with only enough funds to last it through to December. At press time in late March, Zany was trying to restructure payments to First Union on the US$50 million it had already drawn from the line of credit, as well as simultaneously working out a plan to pay back the US$45 million sum it’s on the hook for to unsecured creditors, namely vendors.

Though it’s difficult to overplay the significance that a shaky economy has played in Zany’s misfortunes, many industry players believe the company could have minimized its exposure had it managed key areas of its business differently. Topping that list was the company’s acquisition of its main rival Noodle Kidoodle last spring. While analysts lauded the strategic move at the time (for the most part, both companies were operating profitable stores in different parts of the U.S.), integrating Noodle has proven to be more costly and onerous a task than Zany had anticipated.

While there are logistical and cultural issues to overcome in any merger, some people in the biz, like John Lee, president of Chicago-based toyco Learning Curve, think that Zany was too quick to switch over Noodle locations, which reportedly have averaged sales well below Zany stores.

‘They could have left the Noodle sign and merchandise mix as is, and integrated more slowly. It confused the consumer [who used to shop at Noodle Kidoodle],’ says Lee. Also exacerbating Zany’s situation was its nearly US$10-million (according to industry sources) investment in a strategy that has shown a limited return to date. Both factors, combined with the tightening in capital lending markets, left the retailer vulnerable.

Another of Zany’s problems-one that it shares with several other toy retailers-has been its inability to generate steady sales throughout the year, and especially during 2000 when there were no certifiable toy hits. Though it may seem unfair to fault the retailer for a lack of breakout toys, Zany could have insulated itself against a downturn by broadening its product offering to include perennial hot sellers like Barbie, says Richard Zimmerman, VP of equity research at investment banking firm Janney Montgomery Scott in Philidelphia. However, stocking Barbie (which Noodle had done prior to the merger) would contradict one tenet of Zany’s corporate mission to offer consumers ‘gender-neutral’ educational toys, and as such, could blur the contrast between its own merch assortment and what other mass retailers are offering. But Zimmerman says it’s a compromise Zany must be willing to consider if it wants to remain in business. ‘If you need to boost traffic, you have to give people what they want,’ he says.

Another analyst, who requested anonymity, says that Zany’s biggest problem is that it has overestimated the number of consumers who are willing to pay for high-priced edu-toys. It’s a mistake, he notes, that the company made based partially on the wave of strong sales of Beanie Babies, a specialty-only item that retailers like Zany and Noodle were able to ride during the early and mid 1990s, but whose popularity has since dried up.

‘It sounds silly to say that two retailers got hurt by one product, but Beanies was a huge product line that Wal-Mart and Toys `R’ Us didn’t have,’ says the analyst. Since the Beanie’s drop, he continues, Zany hasn’t had the same share of any other hit toys.

To be sure, bankruptcies and closures of chains have become a constant theme in the specialty toy retail sector. That said, news of Zany’s problems is being met with concern by many in the industry. With mass retailers like Toys `R’ Us and Target carrying more specialty products, vendors say the market for them is expanding. But along with the increase in retail distribution, some say the effect has seen an undercutting of the economics of the sector which, historically, has prospered by selling the values and the quality of a toy rather than its price, says Peter Reynolds, CEO of Germantown, Wisconsin-based toyco Brio.

‘There’s too much retail right now. People are willing to give toys away. Suppliers and retailers are selling products below cost, and when you have that kind of situation, something has to give,’ says Reynolds, who predicts more retail shakeout to come.

If Zany-which has 188 stores-were to fold, vendors say the long-term impact would not be fatal for the industry, since most toycos spread the bulk of their sales amongst independent accounts. Learning Curve and Brio, for instance, sell only 10% and 25%, of their products through specialty chains, respectively.

With its stock price flat-lining at US$0.30 on the news of its financial predicament, and with its Q4 results (which are expected to be well below comparable sales for 2000) yet to come, Zany is in tough to try and survive. At press time, the company had managed to extend its stand-still agreement with its suppliers, giving it a deadline of April 30 to find a new source of capital. To achieve that goal, in March, Zany hired investment banking firm William Blair & Co., which is reportedly exploring a number of alternatives that could involve a possible sale or merger.

Though the last thing toycos want to see is another chain go belly up, for now, many in the industry aren’t willing to bet on Zany’s fate.

‘We’re all feeling cautiously optimistic and appropriately saying our prayers,’ says Learning Curve’s Lee. The upside, he maintains, is that Zany’s performance problems can be easily fixed.

Specialty toy retailers’ year of woe

March 28, 2001

San Marcos, California-based specialty toy chain Play Co. Toys files for bankruptcy protection and begins planning the total liquidation of its assets.

March 22, 2001

Cash-strapped science and edu-toy retailer Store of Knowledge announces a plan to restructure debt owed to vendors. Among other corrective measures, the plan calls for SOK president Jim Berk to forgo his salary till December, as well as for the deferral of US$2 million in royalties owed to public television station partners.

December 17, 2000

Science and educational toy lifestyle chain Natural Wonders files for bankruptcy protection.

August 31, 2000

Toy and hobby retailer The Great Train Store shutters its doors for good.

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