Toys R Us Buys High-End Retailer FAO Schwarz

WAYNE, N.J. – Geoffrey the Giraffe became a knight in shining armor for toy retailer FAO Schwarz late Wednesday, as Toys R Us Inc. said it acquired the troubled high-end retailer, which has struggled for years through bankruptcies amid tough competition from discount stores.

Analysts said privately held FAO Schwarz — immortalized in the 1988 Tom Hanks movie "Big" — was in danger of closing if a buyer did not materialize. Privately held Toys R Us — the largest U.S. toy retailer — meanwhile, will get an opportunity to work with smaller toy vendors, cut costs and operate a marquee store on 5th Avenue.

Toy retailers have been increasingly squeezed by discounters such as Wal-Mart Stores Inc. and Target Corp. as well as online retailers. The consumer spending cutback and recession has added to the pressure, winnowing the weaker players.

KB Toys Inc., Toys R Us' only major direct competitor, did not even make it to the holidays, filing for bankruptcy protection in December 2008 and liquidating its stores.

Although not immune to the tough economy and competition, Wayne, N.J.-based Toys R Us has had stronger results. Toy R Us Chief Executive Jerry Storch said the move could help give it a leg up on discounters.

"The FAO Schwarz name is one of the premier names in toys, and the acquisition enables us to differentiate even further with mass-market competitors," Storch said in a telephone interview.

While the company declined to give specific financial details, "the feeling is they got it for very, very, cheap," said Timetoplaymag.com analyst Jim Silver. "It really allows them to expand and work with a lot of smaller companies they've never worked with."

Storch said the company is still considering a broad range of options for the stores and hasn't made any specific decisions yet, other than it expects to retain store employees. It will operate the company's two stores in New York and Las Vegas. A deal FAO Schwarz brokered with Macy's Inc. to open small locations in 685 Macy's will end in November. Only 260 of those opened and the outposts will be phased out after the deal ends.

"We feel it's a centerpiece for the entire toy industry," Storch said. "We can even be faster with new trends and quicker with the latest toys."

While many retailers reported weak earnings or losses in the all-important fourth quarter, which contained the weakest holiday season in decades, Toys R Us' quarterly profit rose 11 percent as it cut costs, despite a 6 percent sales decline.

It has used its relatively strong position to scoop up competitors. In February, it acquired online toy seller eToys.com, which was operating under bankruptcy protection.

FAO Schwarz meanwhile, has been struggling. The privately held company does not release sales data, but in December, the company's CEO told The Associated Press that like most retailers, the company experienced a drop in overall holiday sales, critical to toy retailers. In March, it replaced its chief executive Ed Schmults with Barry Erdos, the former president of online retail site Bluefly.com.

Known for high-end toys, FAO Schwarz has a history of financial difficulty. The company filed for bankruptcy protection twice in 2003, first in January after a weak 2002 holiday season. It was purchased by D.E. Shaw group in 2004.

Last year, it introduced $20-and-under toys in time for the holiday season, but it never carried "hit" toys like Elmo or Bakugan card game and remained largely dependent on tourists.

An operator like Toys R Us could help improve its own results, analysts said, by bringing in a better mix of specialty toys and toys from major toy manufacturers.

"FAO Schwarz is basically just two stores, if FAO went away wouldn't make one bit of difference for toy makers," said BMO Capital Markets analyst Gerrick Johnson. "But now that its under Toys R Us, there's better opportunity" to drive more sales and sell a wider variety of products, he added.

In return, Toys R Us owns one of the best-known names in the toy industry, Needham & Co. analyst Sean McGowan said.

He added that closing Macy's 260 outposts will likely not be a detriment to the deal since they were only 1 or 2 aisles in each store.

"Keeping the FAO Schwarz brand to stand for what it is, an iconic specialty toy store, is the important thing," for Toys R US, he said. "They served the purpose of keeping the name out there, but Toys R Us will get that in a different way. ... It not only one of the oldest toy brands in the world, it tends to be outsized in people's collective thoughts."

Toys R Us operates more than 1,500 stores worldwide, including 847 in the U.S.