Heavy Dilution
That premium should translate into serious dilution for Mattel as well. Mattel, which already has $1.3 billion in intangibles -- primarily goodwill -- on its balance sheet, will now have to record about $3.6 billion more in goodwill. In the past similar transactions have led to a huge one-time write-offs of such intangibles, thereby avoiding the long-term drag on earnings. However, The SEC is in the process of cracking down on this practice, so we can't be sure if Mattel will be able to write off this huge premium. If it can't it will amortize the $3.6 billion every quarter. Assuming a 40-year amortization schedule, $22.5 million in added amortization expenses would hit earnings every quarter.
The amount of shares Mattel will have to issue in this all-stock deal is staggering. At $30 per share, where Mattel was trading Friday, the company would need to issue 126.7 million shares, which equates to 42% of the shares outstanding at the end of the third quarter. Based on a price of around $23 per share, Mattel would have to issue 165.2 million shares, more than half of the current shares outstanding. If you added that amount of shares to third quarter results, earnings would have been $0.42 per share, 36% below what was reported. This is of course only an example of the magnitude of the dilution. The combined company will also have the revenue and earnings contributions of TLC to offset some of the added shares. But TLC is just not profitable enough to offset the dilution. Before restructuring charges, TLC earned just $44 million ($0.09 a share based on Mattel's newly boosted share count) in the third quarter. With the added shares and net income form TLC, we estimate that third quarter earnings would have been $0.51 per share, well below the $0.66 that Mattel reported. That does not include the added amortization expense, which would have taken another 2 cents off the bottom line. Based on the numbers we have laid out it will be awfully tough for Mattel's management to make this deal accretive as it is currently structured. Even at a price of $30 for Mattel shares, the deal would not be accretive unless some unseen synergies were uncovered.
Michael Perik, CEO of The Learning Co., said he sees tremendous opportunity to leverage the respective brands. What he is basically saying is that he expects the combined company to be more profitable than they are on a stand-alone basis. He is speaking of the ability to cut costs and sell existing products to new customers, thereby creating synergies. There is certainly room for improvement, but as our analysis shows, the results on a stand-alone basis do not come close to justifyingthe steep purchase price.
Bottom Line:
Investors, it seems, agree that the price is too steep. With Mattel's stock dropping like a stone, one of two things will likely occur. Either Mattel will offer TLC shareholders more than the proposed 1.2 conversion ratio, or the deal will be voted down by TLC shareholders. Regardless, we reiterate our stance that investors should avoid Mattel
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