KB Toys — The Mall’s Toy Store, Buried by a Dividend and a Recession

Summary

KB Toys was the toy store of the American mall — small, crammed, fluorescent, the place you ducked into between the food court and the department store anchor — and on December 11, 2008 it filed for bankruptcy for the second time, beginning the going-out-of-business sales that shut all 461 of its remaining stores by February 9, 2009. It is not Toys "R" Us. Where Toys "R" Us was the freestanding big-box, KB was the compact mall specialist, descended from a Massachusetts wholesale candy business that brothers Harry and Joseph Kaufman opened as Kaufman Brothers in Pittsfield on April 1, 1922. The company became Kay Bee Toys, then KB Toys, and at its May 1999 high-water mark it ran 1,324 stores — the dominant toy chain inside America's malls and, by store count, the country's second-largest toy retailer.

The chain died of three things, in order: leverage, the discounters, and a recession. In December 2000 the private-equity firm Bain Capital bought KB Toys for about $305 million, putting in only around $18 million of its own equity and loading the rest as debt onto the company. In April 2002 Bain extracted an $85 million dividend through a recapitalization — a payout creditors would later argue rendered KB insolvent. The chain filed its first Chapter 11 in January 2004, closed more than 600 stores, and laid off over 3,400 of its 13,000 employees, emerging in August 2005 under Prentice Capital Management, smaller and still fragile.

Then came the shock that finished it. Walmart and Target had turned toys into a loss-leading price war a mall specialist with higher rents could not win, and Amazon took the rest. When consumer spending collapsed in the fall of 2008, KB's same-store sales fell nearly 20% in the weeks that should have been its richest — the run-up to Christmas, when toy sellers earn up to half their annual revenue. Citing debt "directly attributable to a sudden and sharp decline in consumer sales," the 86-year-old company filed again on December 11, 2008, with roughly 10,850 employees (about 6,500 of them seasonal). This time it liquidated. The brand was sold to Toys "R" Us for about $2.1 million in September 2009 — the mall toy chain ending up a trademark owned by the big-box rival that had helped bury it.

Timeline

The Store in the Middle of the Mall

KB Toys built its business on a piece of retail real estate logic: be where the families already are. While Toys "R" Us drew shoppers on a dedicated trip to a freestanding warehouse, KB planted compact, densely stocked stores inside the mall, capturing the impulse purchase and the rainy-Saturday browse. The format was the opposite of spacious — narrow aisles, toys stacked to the ceiling, a perpetual clearance bin near the door — and it worked because the rent of a small mall unit could be carried by high-margin impulse buys and a steady churn of seasonal demand. By May 1999 the chain had grown to 1,324 stores, blanketing American malls and ranking as the nation's second-largest toy retailer by store count.

The vulnerability was baked into the same logic. A mall toy store is a high-rent, small-footprint operation that cannot match a big-box on selection or, increasingly, on price. Through the late 1990s and 2000s, Walmart and Target made toys an ideal loss leader — sell the hot item at or below cost to pull families in, then make the margin on everything else in the cart. That weaponized pricing gutted the economics of a specialist that needed toys themselves to be profitable. KB was a healthy, well-known chain in a category quietly becoming a battlefield it was structurally unequipped to fight. What it needed, going into that fight, was a strong balance sheet. What it got was a leveraged buyout.

The $85 Million Dividend

In December 2000, Bain Capital acquired KB Toys for about $305 million. The structure is the part worth dwelling on: Bain contributed only around $18 million of its own equity, the remainder financed by debt that sat on KB's books, not Bain's. This is the standard architecture of a leveraged buyout, and on its own not a scandal. What drew lasting controversy was what came next. In April 2002, through a dividend recapitalization, Bain had the company borrow more to pay an $85 million dividend to its owners; the CEO received $18 million and other executives shared roughly $16 million more. The money went out the door to financiers and managers, and the new debt stayed behind with the company.

When KB filed its first bankruptcy in January 2004, its creditors made the case in public: the 2002 dividend deal, they argued, had rendered KB Toys insolvent, contributing to a $100-million-plus loss before the filing. Bain's defenders countered that the chain was killed by Walmart, Target, and a tough toy market, not the dividend — and there is truth in that, since the competitive squeeze was genuine. But the two explanations compound rather than compete. A chain facing a structural price war needed financial slack to invest, discount, and wait out bad years; the LBO and the dividend recapitalization converted that slack into debt service. KB shed more than 600 stores and 3,400 jobs in 2004, emerged under Prentice Capital in 2005 at roughly 640 stores, and limped into the late 2000s as a debt-scarred version of itself — exactly the wrong condition in which to meet a recession.

The Five Factors

Aftermath

The two waves of closures cost tens of thousands of jobs — over 3,400 in the 2004 round and some 10,850 affected in the 2008–09 liquidation, many of them seasonal workers laid off in the dead of the holiday season they had been hired to staff. The store leases reverted to mall landlords already watching anchor tenants wobble, and the small bright KB units joined the inventory of dark mall space that would define the next decade of American retail. For the workers, the timing of the final filing — December, payroll swollen with holiday hires, the going-out-of-business banners going up before Christmas — was its own quiet cruelty.

The brand's fate is the tidy irony. Toys "R" Us bought the KB Toys name for about $2.1 million in 2009 and let it sit; when Toys "R" Us itself collapsed years later, the trademark drifted on through the usual after-market of dormant retail brands. KB's larger legacy is as Exhibit A in the long argument over the private-equity playbook: the buyout that takes a functioning chain, finances the purchase with the target's own debt, pays the owners a dividend funded by still more borrowing, and leaves a weakened company to meet the next recession with no reserves. KB did not invent that pattern, and it was genuinely battered by Walmart and Target besides — but the dividend and the debt are why it met the recession with empty hands.

Lessons

References

• KB Toys files for bankruptcy protection NBC News / Associated Press
• KB Toys closing its doors 6abc Philadelphia (WPVI / AP)
• Video blames Bain Capital for demise of KB Toys PolitiFact
• Fact Check: Facts Strained in 'King of Bain' Center for Public Integrity