The Money Game: The Financial Realities of the Toy Industry
By now, it should come as no surprise that the financial structure of the toy industry is unique and uniquely challenging.
The primary—and somewhat obvious—reason for this is that approximately 50 percent of the year’s retail sales are made in the Fourth Quarter, with the bulk of those (as much as 25 percent of the year’s total sales) coming in December. Not to be overly dramatic, but two years of effort, planning and expense face a make-or-break 20 days at the end of the year.
Ranking toy companies is never an easy task. Privately held toy companies like MGA Entertainment do not have to report their sales, and there are many conglomerates like Disney, which generates only part of its revenue from toy sales and licensing. Similarly, VTECH which is also in the phone and electronic business does derive part of its revenue from toy sales, as does Bandai, but these companies do not break out the specific contribution of toys to their overall performance.
Traditional, publicly traded toy companies in the United States ranked by revenue for 2014 are:
Mattel—$6.02B
LEGO—$4.67B
Hasbro—$4.28B
Jakks Pacific—$810.00MM
These are what would be considered the top tier toy companies. The second tier and below are all smaller companies, and of the approximately 600 toy companies in the United States, and their revenues are wide ranging. Companies in the top 25 might have revenues of $150MM, while there are many in the $20–25MM range, and even some companies that are profitable on revenues of $5–10MM. It varies by product and, of course, the make-up and objectives of the specific company.
This concentration of a few companies in the top tier is the result of a variety of factors, largely acquisitions. Of these, LEGO is the only one that has not grown through acquisition over the years. They’ve done it solely on the basis of expanding product.
During the mid-1960s and 1970s, the overall trend of corporations diversifying their holdings inspired many major corporations to get into the toy industry. The toy companies, many of which had been family businesses, were only too willing to cash out. What followed was a massive absorption and consolidation of small companies that lasted until the early 1980s. What the major corporations had not anticipated was that the nature of the toy business would end up being a drag on the balance sheet for three quarters of the year, with the hope of making it up with all-important holiday sales.
Here are just a few examples of how companies were bought, sold, combined, and reconfigured over the years as names that Baby Boomers recall with great affection became part of larger companies that focused on toys.
CBS, the broadcaster, got into the toy business in 1966 with the acquisition of Creative Playthings, a company that made wooden preschool toys. The rationale, as the story goes, was that founder William Paley’s wife liked the products, so Paley bought the company. CBS would later acquire Gabriel Toys, educational toymaker Child Guidance, swing set maker Gym-Dandy, spring horse maker Wonder Products, and one of the biggest toy companies of the 1950s and 1960s, Ideal. In 1985, as Laurence Tisch began controlling CBS, he began the process of divesting the corporation of the companies it had bought (which also included Steinway Pianos and Fender Guitars among others) and focus on its core businesses. Creative Playthings had become a brand of wooden playground equipment by that time, and it was sold to a company in Framingham, Massachusetts. Jakks Pacific ultimately acquired Child Guidance, and the Ideal brand is currently being revived by Alex Brands. For the most part, as we’ll see in a moment, different toy companies cherry-picked the assets of the companies as they were shutting down.
Hasbro also grew steadily through acquisition. Founded in 1923, the company had been known primarily for school supplies—at least until it debuted Mr. Potato Head in 1952. Hasbro began acquiring toy companies in earnest in the mid-1980s. In 1984, Hasbro bought Milton Bradley, which had previously acquired Playskool in 1968. General Mills, the cereal company, had acquired classic game maker Parker Brothers in 1968, later combining it with Kenner Toys. These were combined as Kenner Parker toys and sold to Tonka in 1987. Hasbro picked them all up in 1991. Hasbro acquired Avalon Hill Games in 1998, which had previously absorbed 3M games in 1976. Hasbro also acquired Tiger Electronics and Galoob toys in 1998. Wizards of the Coast had acquired TSR, makers of Dungeons & Dragons in 1997, and Hasbro picked them up in 1999. Hasbro’s most recent acquisition was the game company Cranium in 2008.
Jakks Pacific has grown primarily through acquisitions over its relatively short history. Founded in 1995, two years later it acquired Remco, Child Guidance, and carmaker Road Champions. In 2002, it acquired Toymax and Go Fly a Kite. A year later, it acquired Trendmasters, and in 2004, it acquired Play Along Toys. In 2008, it acquired Kids Only Toys, dollmaker Tollytots, and costume maker Disguise. Throughout the years, it acquired a variety of other related companies expanding into the pet and stationery businesses.
Mattel, too, has had its share of acquisitions, though not quite as many as Hasbro. Founded in 1945, Mattel had originally made picture frames with a smaller business in dollhouse furniture. Two years later, it began making musical toys including the Uke-A-Doodle and Jack in the Boxes. In 1995, the company teamed up with “The Mickey Mouse Club” and also began making the cap pistols that Baby Boomers craved. Of course, Barbie followed in 1959, and the company never made a picture frame again. Over the years, the company made many hit toys, but it didn’t start acquisitions until 1986, when it purchased ARCO Toys. In 1988, it purchased upscale dollmaker Corolle. In 1989, it acquired die-cast carmaker Corgi. In 1991, it bought Aviva Sports and a year later International Games. In 1993, Mattel acquired Fisher-Price, which had been owned by Quaker Oats from 1967 to 1991, when the company became independent. In 1997, the company acquired Tyco and with it the Sesame Street name and Matchbox, the latter having been acquired by Tyco in 1992. In 1998, the company bought the British company Bluebird Toys and with it the popular Polly Pocket Brand. A year later, it acquired The Learning Company in a move that turned out to be a mistake as educational software wasn’t part of the company’s expertise. Mattel would divest itself of different brands over the years as well as it continued to focus on its core businesses. It acquired HIT Entertainment in 2012, producers of the popular series Thomas the Tank Engine. This gave the company a foot-hold in the entertainment business and ownership of Thomas, which it had previously licensed and for which it will now receive the revenues from Thomas licensees all over the world. In 2015, Mattel acquired MEGA Brands, and in 2016 it acquired Sproutling, a manufacturer of baby monitors and Fuhu, a youth electronics company acquired out of bankruptcy.
No one will blame you if your head is reeling from all of this. There were several reasons for all these acquisitions. First, now that the companies were publicly traded, one of the surest ways of demonstrating growth was through acquisition. Second, as the toy industry became more and more international, the assets of the companies acquired included factories, international subsidiaries, and broader opportunities for distribution.
Also not surprising is that the rate of acquisitions in recent years has slowed considerably. As with the first boom of acquisitions in the 1960s, most are small, privately held companies whose owners are ready to cash-out.
Far more common in today’s market is the acquisition of certain assets, brands, or products. A major company is far more likely to acquire a brand or an item from a small company in order to give it wider, mass-market distribution rather than the entire company with all its potential liabilities.
Similar consolidations have happened in the retail sector, though not as much by acquisition. In the years after World War II, sales were concentrated locally in major department stores. The only national store at the time was FAO Schwarz, which was an institution and did a huge mail order catalog business and Kay-Bee toys from 1922 that specialized in close-outs, ultimately. Toys “R” Us was founded in 1948 to be a “toy supermarket.” This was perfect for the Eisenhower years, and later in the early 1960s, Lionel Leisure and Kiddie City Stores followed. Woolworth’s, Kresges, and Sears were all major players in the category as well, and many Baby Boomers remember growing up with the Sears Wish Book and plotting what they would be putting on the lists for Santa.
From the 1970s to the 1990s, retail in general was consolidated as large conglomerates bought local stores and that included toy stores. From the 1960s on, Toys “R” Us bought regional toy chains and consolidated them under the Toys “R” Us banner. Given its size, it was able to continue to sell toys at a discount, undercutting department stores who eventually abandoned toys. But Toys “R” Us, which had gone public in 1978, would get a taste of its own medicine as booming retailers Wal-Mart and Target were undercutting Toys “R” Us on price and taking a significant share of the business. In 2005, Toys “R” Us was bought by a private equity group consisting of Kolberg Kravis Roberts & Co, Vornado Realty Trust, and Bain Capital Partners in a leveraged buyout. Plans for an initial public offering IPO collapsed after a challenging 2011. The company has since been struggling, undergoing many management changes, facing renewed competition, and unable to position itself for an IPO.
Today, the toy retail market, is dominated by Wal-Mart, Target, Toys “R” Us, and Amazon. Wal-Mart and Target are likely to carry only the most in-demand and promoted items in a given year—perhaps 1,200 different items. Toys “R” Us, on the other hand may carry as many as 7,000 different items. Wal-Mart and Target do have an advantage in that they can offer popular toys at deep discounts as a way of driving traffic into the stores. Any profit they give up, they hope to make up on other items consumers purchase while in the store. Wal-Mart and Target are more concerned about the gross margins of the entire purchase rather than just an individual item. Amazon, on the other hand, is valued on its revenue per visitor, a version of the market basket play, rather than on the profitability of an individual toy. So, it, too, can undercut Toys “R” Us on price. Toys “R” Us’ current strategy is to be in stock on key items when other stores have sold through their allocation. In the past several years, this has worked as the last two weeks before Christmas made the chain profitable.
And then there are consumer buying patterns. In recent years, retailers have taken early markdowns on products in October and November, sometimes drastically. What this has done is condition shoppers to wait until the last minute—sometimes the last weekend before Christmas—to buy toys because of anticipated sales. (The exceptions of course are so-called hot items that may be sold out.)
These unplanned markdowns can be a cause of contention between manufacturers and retailers as retailers may request discounts or markdown allowances that haven’t been planned. This is what we mean when we say that no two deals are the same, and no sale is final until it is. The negotiation, according to people involved in the process, is almost never ending. And right after the holidays, the next year kicks into high gear.
From a manufacturer’s perspective, the toy industry remains a capitalintensive business, and, as should be perfectly clear by now, it’s one for which there are no consistent business models or formulas for success. Essentially, large companies like Mattel or Hasbro will have to invest for 18 months or more before they begin to know whether or not their investment is going to pay off. That window is slightly smaller for a mid-size company, and for small, independent companies, that window can be a year or less. Still the costs for design, molds, samples, packaging, shipping, sales, and so forth are all allocated and spent before the first reads on sales are available.
For companies like Mattel and Hasbro, sales across a portfolio of products generate the revenue that allows them to invest in research and development. In recent years, the emphasis within these companies has been on looking for acquisition targets that will expand a portfolio both to enhance retail relationships and how the company is viewed in the investment community. Thus, for Hasbro, there has been a solid expansion of the NERF brand, which now incorporates Super Soakers. In most cases, this has little or no impact at the consumer level where decisions are still made on the basis of individual products rather than buying more deeply in a brand. Conversely, the move to merge all Hasbro word games under the Scrabble brand was confusing, a move that Hasbro has since backed away from. Mattel’s standard portfolio includes Barbie, Hot Wheels, and other brands. While there are inevitable fluctuations year to year, these core businesses provide a relatively stable foundation for new introductions and expansion.
For smaller companies, particularly independent and start-ups, raising money can be very hard. For many years, smaller companies used factors, companies that purchased accounts receivable for 75 to 85 percent of the total, which gave companies the cash flow they needed to function throughout the year. This minimized certain amounts of risk by transferring ownership to the factor, but it was expensive. Today, it’s far more common to have investors with an ownership stake in a company or for a company to be in partnership with a manufacturing concern or other partners to reduce up front costs.
Online investment opportunities like Kickstarter have been touted as a way to fund small companies and individual products, but their success has been uneven. The best products have been sufficiently developed with this type of investment to create distribution deals with larger companies, but investors are limited in what they can realize. It’s more popular than practical.
Still, as many small toy companies will attest, finding these partnerships or raising money is not easy in a world where investors are looking for proven business models or categories of goods that have consistent performance, rather than taking a gamble on sales dependent on the whims of a child. Essentially what toy companies are asking potential investors to do is to buy into a vision and creativity, and the track record of the people involved. In this way, the toy industry is more closely analogous to the entertainment business, where investors are asked to invest in a concept. But, as with show business, only a percentage of the toys introduced become profitable and fewer become long-term sellers, so anyone investing in the toy industry should only be playing with money they can afford to lose.
At the same time, many toy companies are shifting the costs of research and development and even initial production to smaller companies, acquiring products for distribution, or working with inventors to reduce risk.
With respect to public versus private ownership, it’s almost always better for toy companies be privately owned. It’s much easier for a private company to weather the cyclical nature of the business rather than being held to account by shareholders and Wall Street for the quarter when performance is going to be down. In the early 1970s, as many large corporations sought to expand and diversify, they bought up toy companies. CBS, Inc. ultimately acquired five toy companies, only to divest itself of them in the mid-1980s when the toy company’s natural performance created a drag on the overall numbers that wasn’t always wholly offset by one quarter of strong sales.
The reasons to go public are the same as in any other business—to raise capital for expansion or for owners to cash out. With the latter, it’s much more likely for a company to try to cash out through going public when private equity has been funding the company. In this scenario, a company that may be underperforming is bought out by a private equity firm, returned to a strong level of performance and then off-loaded through going public. The unique challenge of the toy industry is that because this is a product-driven business, a company can be streamlined, downsized, and made attractive on paper, but at the end of the day, one hit product or one major failure can change the entire financial picture for a company. This tends to make investors wary, again because there are few accurate predictors of consistent success over time.
For publicly traded companies, the stock price sometimes reflects current sales, but more often is a gamble on the future. The best investment analysts look not just at the current numbers but the larger cultural impact of what’s driving them. Whether it’s the broader-based popular culture, research with suppliers, or drilling down into the fundamental performance of the business, analysts come up with a buy or sell recommendation based on the stock price. And, analysts can be as right or wrong as anyone else when dealing with the unknowable—such as how a movie or TV show is going to perform and whether it has been translated into toys that children will love—and children are notoriously oblivious of the effects of their whims on stock prices. Certainly in talking with analysts over the years, they do put a lot of emphasis on how the product portfolios mentioned above perform. This is perceived as the core business, and for many years, for example, the valuation of Mattel was based primarily on the performance of Barbie in the market. Providing ongoing analysis on publicly traded toy companies is a challenge. Since so much of the product is new every year, it’s very difficult to determine whether a company is on the rise, is flat, or declining. Moreover, stock prices don’t always reflect current performance. The announcement of a license for a movie two years down the road may be sufficient to keep the stock price up because of anticipation that toys from the movie will do well. This can happen even if the sales in the current year are lagging. This is the case when the investment is a longer-term play, and as one analyst who asked not to be named said an investment bank has a great deal of money that they have to put somewhere, so the job is to find places where they can invest that will mitigate risk and have potential for growth. Still, understanding the changing nature of the toy industry provides unique challenges to investors and the investment community.
As with the products themselves, investing in the toy business will continue to be something that happens on an individualized basis and that isn’t necessarily dependent on logic. In the private world, many people think they have the insight to know what’s going to work. Sometimes they’re even right. In the public world, toy stocks are more of a gamble, and the investments are made not so much on the individual toys but the track record of the company, its overall performance relative to expectations and predictions (commonly called “guidance”), and knowledge of the industry in all its various and unpredictable guises.