Toys 'R' Us Bondholders Form Group to Seek Covenant Relief

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NEW YORK (The Deal) -- Certain bondholders of Toys 'R' Us Inc. have formed a group to seek covenant modifications with a goal of making refinancing for the retailer easier, according to a bondholder.

One path toward refinancing -- and a hoped-for turnaround -- would be to pursue a sale-leaseback deal for its domestically owned properties, that person said.

"There's a strong market for sale-leaseback transactions," the investor said, citing American Realty Capital Properties Inc.'s $1.5 billion sale-leaseback deal for 500 Red Lobster restaurants as one recent, sizable example of such a single-tenant deal. That deal closed July 28 as part of Golden Gate Capital's acquisition of Red Lobster from Darden Restaurants Inc.

Other retailers that have used the value of their real estate to secure debt revamps recently include J.C. Penney , Sears Holdings and SuperValu .

"It's a pretty well-worn path," the investor said.

The real estate could also be used as security for a loan, likewise gaining the company a "substantial" interest rate savings over an unsecured deal, the investor said. A combination of a new loan and a sale-leaseback deal would also be a good option, the bondholder said.

However, at the moment, a pesky debt covenant stands in the way for Toys 'R' Us. The limitations on liens covenant on the 7.375% holding company bonds due 2018 restricts the company's ability to grant liens on its assets.

The investor understands that the bondholder group, which has been formed in recent months, is seeking relief on that covenant.

The person said that though the company's earliest debt maturities aren't until 2016, given the favorable state of credit markets and the uncertainty surrounding the company's operations and the retail industry in general, Toys 'R' Us should kick a refinancing effort into gear in the next month or so.

That initiative may be crucial to the financial health of Toys 'R' Us going forward. Observers are watching the company's performance in 2014, as it has about one to two years to execute a turnaround, industry sources said.

A source who specializes in the restructuring of private equity portfolio companies said that if Toys 'R' Us has stable revenue and operating income, but is losing money, then it is a balance sheet problem partially due to the debt servicing and can be fixed.

However, if operating income is drastically falling, the problems could be deeper and indicate that the business may not have long-term viability.

The company went private in 2005 when a private equity consortium including Bain Capital LLC and Kohlberg Kravis Roberts & Co. LP, as well as Vornado Realty Trust, bought it for $6.6 billion.