After a hard-fought battle in the toy trenches, Toys ‘R’ Us is separating its booming Babies ‘R’ Us business from its faltering global retail operation, in preparation for the possibility of selling off its 1,200-plus toy stores. The missive has touched off a flurry of speculation by industry insiders and analysts that has yet to settle down – particularly since TRU won’t be making any further public statements for some time due to shareholder obligations.

The company continues to struggle for profitability on the toy side, with first quarter results (February 2 to May 1) showing a net loss of US$28 million and an average store sales decrease of 5.6%. Babies ‘R’ Us, on the other hand, reported a total sales increase of 9.6% and operating earnings of US$63 million, up 17% from the same period in 2003.

And as for the restructuring scheme, here are the facts thus far. Toys ‘R’ Us took a US$150-million hit for inventory markdowns in its fiscal Q2 from May 2 to August 1 (at press time, the company had not reported financial statements for the quarter) so it can begin clearing out inventory in its U.S. toy stores, as well as generating some extra cash in time for the all-important holiday season. But the chain will not look at closing locations until the beginning of 2005. TRU is also working on reducing operating and capital expenses for its global toy biz by US$125 million for fiscal 2005, though it will set aside US$14 million for severance and related costs involved in scaling down its HQ operations in Wayne, New Jersey. CEO John Eyler will remain in his post.

Toy biz players are left wondering how this will play out – particularly in the hyper-competitive U.S. toy retailing market, where discount giants Wal-Mart and Target have effectively taken over the business. Price, it seems, has become the primary influence on toy purchase decisions, further highlighting the commoditization of the industry. Speculation is running high about who will want to buy the toy business if TRU can’t compete in this climate, and what direction the company will take to restructure its store operations. Will it refocus on the specialty toy market and leave the rest to mass retailers? And more immediately, what will this US$150 million in markdowns do to overall toy sales in Q4?

Joe Diaz, president of specialty retailer Learning Express, says he expects Q4 to be a challenge. Following two straight years of specialty chain FAO Schwarz declaring bankruptcy and blowing out inventory, he wonders how smaller retailers and toycos will withstand a third year of deep-discount, ‘going-out-of-business’ sales. He also points out that no one knows if privately held KB Toys, which also declared bankruptcy after last year’s holiday toy wars, will restore itself to profitability or throw in the towel and liquidate its outlets during the peak season, serving to further clog the pipeline with inexpensive toys.

As for Learning Express itself, Diaz says the 120-store chain can ride out the storm, explaining that the company made a firm decision not to compete on price these last two years, focusing instead on maintaining its unique product mix and customer service perks.

Diaz also observes that this announcement may mean TRU’s recent focus on launching super-sized, kid-pampering Geoffrey stores has been unsuccessful in changing the direction of its retail strategy.

If TRU fails to find a buyer for its toy stores (keep in mind that Disney has had its retail outlets up on the block for two years), many are also speculating about the long-term impact on toy manufacturers. Finding another retailer to fill out 20% of sales will be difficult, not to mention limiting to R&D initiatives. As Diaz puts it, ‘How much risk would you take if you knew in advance that Target and Wal-Mart buyers weren’t interested in an innovative idea you had?’