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June 22, 2005 Research Digest Research Associate: Lopamudra Mitra Editor: Nachiket Moghe, CFA [email protected]

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Toys "R" Us Inc. (TOY – NYSE) $25.76 Note to reader: This report contains substantially new material. Subsequent editions will have new or revised material highlighted. Reason For Report : Earnings Update

Overview Headquartered in New Jersey, Toys “R” Us Inc. (TOY) is one of the world’s largest retailers of children’s products, sells its goods via Toys “R” Us toy stores, Babies “R” Us infant-toddler stores, its website www.toysrus.com , and mail-order catalogs.

On March 17, 2005, Toys “R” Us concluded its strategic review and announced that it had entered into an Agreement and Plan of Merger (dated March 17, 2005) with Global Toys Acquisition, LLC (“Parent”) and Global Toys Acquisition Merger Sub, Inc. (“Acquisition Sub”) to sell its entire worldwide operations, including both their global Toys “R” Us and Babies “R” Us businesses. Parent and Acquisition Sub are entities directly and indirectly owned by an investment group consisting of entities advised by or affiliated with Bain Capital Partners LLC, Kohlberg Kravis Roberts & Co., L.P., and Vornado Realty Trust; collectively called Sponsors. Under the terms of the agreement, Sponsors will acquire all of the outstanding shares of Toys “R” Us, Inc. for $26.75 per share, representing a transaction value of approximately $6.6 billion in addition to the assumption of debt. Consummation of the proposed merger is subject to various customary conditions, including adoption of the Merger Agreement by TOY’s stockholders, receipt of debt financing by Parent, the absence of certain legal impediments to the consummation of the proposed merger and the receipt of certain regulatory approvals. It is expected that the proposed merger will occur by July end; however, there can be no assurance that the proposed merger will be consummated. According to one analyst (B. of America), mergers and acquisitions are likely to spur more U.S. high- yield bond sales this year, but issuance will be far below 2004 totals. Issuance is expected to total just $90 billion to $95 billion this year, down from $157 billion in 2004.

TOY’s fiscal year ends January; all calendar references are to the fiscal year.

Sales 2002A 2003A 2004E 2005E Net Sales $11,305 $11,320 $11,082 $11,272

During the first quarter, comps in the U.S. toy store division decreased 0.7% vs. a 5.6% decline during last year’s Q1 and a 1.5% decline in 1Q03. First quarter video merchandise sales increased 14% year over year following a 25% decline in videogame sales during the first half of 2004. Older

The Babies “R” Us business reported a solid 4.3% comp-store sales gain.

At toysrus.com, net sales during the first quarter rose 20.8% to $64 million, with strength across all product categories.

See the TOY consensus earnings model for more detail on the analysts’ sales estimates.

Margins

Margins 2002A 2003A 2004E 2005E Gross 31.0% 32.5% 33.0% 33.0% Operating 4.2% 1.9% 3.6% 4.2% Net 2.0% 1.8% 2.0% 2.0%

First quarter video merchandise sales increased 14% year over year following 25% decline in videogame sales during the first half of 2004. Video product sales carry lower gross margin, which drove an overall decline in net margin for the period and resulted in a first quarter operating loss of $32 million versus a loss of $15 million during the year-ago quarter.

Operating loss for the international division was $20 million in Q1 compared to $14 million loss in 1Q04.

In the Babies “R” Us business, operating earnings rose 3.2% year over year to $65 million.

At the toysrus.com division, operating loss declined to a loss of $2 million from a loss of $5 million during the year-ago period.

See the TOY consensus earnings model for more detail on the analysts’ profit margin estimates.

Earnings Per Share The Digest Average for FY05 is $1.04.

FY ends January 2004A 1QA 2QE 3QE 4QE 2005E Digest High $0.82 ($0.19) $0.09 $0.00 $1.33 $1.12 Digest Low $0.82 ($0.19) $0.01 ($0.13) $0.95 $0.93 Digest Avg. $0.82 ($0.19) $0.04 ($0.09) $1.13 $1.04 Digest YoY growth 10.8% 171.4% 33.3% -53.9% 0.2% 26.3% Mgmt Guidance TOY posted a first quarter loss of $0.19 per share, compared to $0.13 loss a year ago (including $0.06 of charges) and the consensus estimates of $(0.03). The above-expected loss was primarily attributable to 100 bps y-o-y decline in gross margin and about $0.03 worth of "strategic review" expenses.

See the EPS and Recent Revisions tabs in the TOY consensus earnings model for more detail.

Zacks Investment Research Page 2 www.zacks.com Target Price / Valuation

Only two analysts (Smith Barney and Jefferies) have projected their target prices of $26.75 and $20.00, respectively. One analyst (Smith Barney) has rated the stock Hold, while another (Jefferies) rated it as Underperform. The Digest Average is $23.38. This average is representative of the target prices projected by the two analysts (Smith Barney and Jefferies).

Go to the valuation tab of the TOY earnings model spreadsheet for more detail on the brokers’ valuation methodologies and individual price targets.

Long-Term Growth

Long-term growth rates for TOY ranges from 5% (Piper Jaffray) to 12% (Smith Barney). Digest average long-term growth rate is 9.1%.

Additional Discussion

FINANCING OF THE MERGER

In connection with the proposed merger, if consummated, Parent will require approximately $6.6 billion to be paid to TOY’s stockholders and holders of other equity interests in the company. These payments are expected to be funded by a combination of equity contributions by Sponsors’ affiliates to Parent. Affiliates of the Sponsors have collectively agreed to contribute, subject to the satisfaction of certain conditions, $1.2 billion of equity to Parent and the remaining funds necessary to finance the proposed merger are expected to be obtained through Parent’s and its subsidiaries’ debt financing. Parent has obtained equity and debt financing commitment for the transactions contemplated by the Merger Agreement, which are subject to customary conditions. In connection with the execution and delivery of the Merger Agreement, Parent obtained commitment to provide approximately $6.2 billion in debt financing (not all of which is expected to be drawn at closing) consisting of (a) a $2.85 billion U.S. asset-based debt facility (the “Asset-Based Facility”), (b) a $2.0 billion bridge facility (the “U.S. Bridge Facility”), (c) a $1.0 billion European bridge facility (the “European Bridge Facility”) and (d) a $350 million European working capital facility (the “European Working Capital Facility” and the European Bridge Facility, together called the “European Facilities”). Parent expects to use these facilities and existing debt, and may use alternative financing to fund the proposed merger.

The chairman and CEO of Toys “R” Us Inc. will quit the company after the proposed sell out to a private consortium is complete.

Individual Analyst Opinions POSITIVE RATINGS None

NEUTRAL RATINGS

Zacks Investment Research Page 3 www.zacks.com Smith Barney – Hold ($26.75): Report date 06/10/06: The analyst maintains a Hold rating on the stock following management’s announcement that it had concluded strategic review and reached a definitive agreement to sell the entirety of its worldwide operations, including both its global Toys “R” Us and Babies “R” Us businesses, to an investment group. NEGATIVE RATINGS

Jefferies – Underperform ($20): Report date 06/10/05: The analyst has rated the stock Underperform believing that the stock price adequately reflects the value to be derived from the sale of the company. The analyst is suspending research coverage of Toys “R” Us in view of the proposed sale of the company.

Zacks Investment Research Page 4 www.zacks.com