OYS R US HAS LONG-TERM VALUE AT A RISK

I had just started school when Charles Lazarus decided his father's bicycle-repair shop needed to change. He went to his bank, borrowed $2,000 to go with the $2,000 he had saved, converted the shop to a children's furniture store and laid the foundation for the largest toy retailer in the world. Over a 10-year period, 1948 to 1958, he went from startup to three stores with the third being the pattern for Toys "R" Us.

The third store, opened in 1958, was a 25,000-square-foot discount toy store. Customers could choose from a broader inventory than at other retailers and pay less. Prices in this store were 20 to 50 percent less than at other toy stores.

Over the next eight years, Lazarus added one store and increased annual sales to $12 million. Needing money to expand, he sold his company to Interstate Stores (a discount-store operator) for $7.5 million and retained control of the toy operation. Competition from larger retailers like Kmart drove the parent company, Interstate, into bankruptcy by 1974; but Lazarus' toy stores were growing with year-round (not just Christmas) sales. By 1978, he was generating enough profit to pull Interstate out of bankruptcy and gain control of the company.

Under Lazarus' control, Interstate Stores was renamed Toys "R" Us with the "R" backwards to grab attention. Today, it is the largest toy retailer in the world with more than 900 stores in the United States and 1,400 worldwide. The company has plans for continued expansion, is remodeling for its "Concept 2000" format, and is reducing costs in response to a higher volume of lower margin business.

During the 1990s, many of the company's closest competitors failed. These failures and other complaints led to an FTC lawsuit for trade violations. In 1997, a federal judge found that the company was in violation of trade laws. According to this judge, Toys "R" Us used its clout to persuade manufacturers not to sell popular toy lines to competitors and conspired with them to keep prices of many popular toys artificially high. This ruling and the ensuing settlement have had a negative impact on both earnings and stock price.

The company recently announced a very interesting dividend for those who are holders of record on Jan. 22. The dividend will consist of one Right per share of stock held on this date. Each Right will initially entitle the holder to buy one share of common stock for $175. There is not room here to go into detail about the other terms and conditions stipulated for these rights. Nevertheless, it is obvious that they are a form of "poison pill" (conditions that would be activated and become very painful for any entity attempting a hostile takeover).

I have seen or heard nothing that would indicate that a takeover, friendly or hostile, may be imminent. However, the structure of the terms in this Rights plan indicate that the Board of Directors may be concerned. A summary of the terms of the Rights plan is available from the company for those who want to know more.

Since early September, the price of the company's stock has declined from about $37 to trade in the $26 to $30 range. The current price earnings ratio (P/E) is about 15 while the market average P/E remains near 25. The market average suggests that the stock should be trading closer to $48. My research suggests a price of $45 is more appropriate. Either way, it seems the market is continuing to punish the stock more than is justified by current and expected earnings after considering the impact of the court settlement.

Last week there were some large block trades in the $27 to $28 range while at least two analysts were reducing their recommendations on the stock. The analysts cited the Far East currency crisis as one reason for concern. The stock closed at $27 9/16 Wednesday. At these prices, it seems the market may have already discounted the Asian risk associated with this stock and more.

Though I do not own any of this stock, I do think there is value in it for the long-term investor. As always, there is some risk involved, and there may be a little more than usual because of the trade violation findings and income-stream exposure to volatile currency markets.

Dividend Reinvestment Plan: No

Web Site: http://www.tru.com

Bill Walker is President and CEO of Walkrich Investment Advisors and completes a market appraisal of over 5,000 common stocks each week.

The Southeast Missourian does not recommend that readers buy or sell stocks featured in this column, which is provided for informational purposes only.