The FAO Schwarz Saga Continues

Toys marketer FAO Schwarz, part of bankrupt parent firm FAO, may have narrowly escaped a shutdown when an 11th-hour buyer swept in just after Christmas. But many industry observers question what the new owner will do with the direct business.

On Dec. 26, FAO — which earlier that month had filed for bankruptcy for the second time in a year — signed an agreement to sell most of the assets of FAO Schwarz to VGACS Acquisition, a subsidiary of DE Shaw Laminar Portfolios, for $20 million. The sale is subject to approval of the supervising bankruptcy court. King of Prussia, PA-based FAO had already started liquidating its Zany Brainy retail chain, and on Dec. 24 it had agreed to sell its 34 The Right Start stores to private equity firm Hancock Park Associates.

The FAO Schwarz deal includes the catalog/retail business, the lease of the fabled Fifth Avenue store in New York, and its Las Vegas store. FAO, however, has to sell the remaining inventory in the two stores. FAO has to ask the court to approve the deal or accept a better bid by Jan. 22.

VGACS plans to close the New York and Las Vegas stores temporarily and reopen them in the middle of the year. It hasn’t discussed plans for the FAO Schwarz catalog.

Donald Libey, president of Cherry Hill, NJ-based investment banking consultancy Libey-Concordia, believes that VGACS — or any other company that offers a better bid before the court makes its decision — will find continuing the catalog and online sector profitable only if it already has operations in place to support a direct business. “So much at FAO depends on whether the acquirer is a catalog company with a catalog operations platform or not,” Libey says. “If it is, and it can compete with the Toys ‘R’ Us alliance with Amazon, fine. If not, there is little likelihood a competitive catalog platform can be assembled in time to save what is, essentially, a brand name.”

Stan Fridstein, general partner of Agura Hills, CA-based catalog and retail consultancy Synapse Infusion Group and a founder of The Right Start, says it could be difficult to turn FAO’s direct business into a profitable venture without also purchasing FAO’s approximately 15 stores. If the stores are not part of the deal, the new owner is going to need deep pockets to cover the direct sector’s overhead costs. “The online business and catalog were not a large percentage of the total business,” he notes. “If you had to have it without the retail, what appears to be profitable might not be as a stand-alone.”

But Ken Hakuta, a Washington-based entrepreneur who had considered buying the company in partnership with Calyx & Corolla founder Ruth Owades, says he would still be interested in acquiring the FAO name, along with the catalog and online operations. “I really love the name FAO Schwarz,” says Hakuta. “I used to run an e-commerce site, and Ruth is familiar with the catalog, so together we could run those quite well.”

In fact, it was FAO’s flagship store that scotched the deal for Hakuta and Owades. They decided not to pursue the company after learning that the bankruptcy court will most likely not allow the buyer to lease the New York store at the fixed lease rate of around $90 per square foot. The company has 13 more years left on the lease, and the court is expected to require the buyer to pay the prevailing market rate of around $180 per square foot for the space in order to provide the greatest possible compensation to FAO’s creditors.

“We knew we could not afford the $180 per square foot,” Hakuta says. “We would end up right in bankruptcy again. No toy retail store could afford it.”

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