Industry Snapshot
Monday, June 25, 2001
Toys & Games:
Fun should return after a lousy 2000 that saw the top firms stumble badly
By Amy Reeves
Investor's Business Daily
For the toy business, 2000 was no playtime. The big toy makers faced deep debts after an orgy of acquisitions, high-stakes licensing deals and a so-so holiday season that closed out a no-growth year.
But small players managed to enlarge their slivers of the market. And the giants see better times ahead as new managers and a more cautious approach to spending take hold.
It remains to be seen if it will work. But the industry can count on one thing: as long as there are children, they will want toys.
1. BUSINESS
The industry includes not just toys but board games, scooters, crayons and crafts, and random collectibles like baseball cards. Not all the items are just for kids, but the market is overwhelmingly juvenile.
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Image: Who's Who In The Group
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Some firms spill over into related fields: Topps Co. (TOPP) makes comic books and candy, and First Years (KIDD) makes baby goods like bottles and teething rings as well as fun stuff.
The products are mostly sold to stores, but a few firms such as Equity Marketing (EMAK) make toys for promotions in fast-food chains and the like.
Given the fickle nature of kids' tastes, firms must be diverse to last. But those that gambled away profits with buyouts and licensing deals — as Mattel (MAT) and Hasbro (HAS) have done — find costs outrunning revenue.
The most profitable now are midsize firms such as Jakks Pacific (JAKK), with a pre-tax margin of 16% last year, and Topps, at 26%. They're larger and fairly diverse but have not spent themselves into the ground. Stock-price wise, Action Performance (ACTN) has soared fivefold to 25 since February as it has returned to profitability.
Name of the game: Companies live and die by the fickle tastes of kids, so the key is to “think like a kid,” said Jakks President Stephen Berman. Those tastes can be mercurial, so managers must cope with ups and downs.
“The most successful toy companies are those with the best products and the capability to manage trends and fluctuations year in and year out,” said Melissa Williams, analyst with Gerard Klauer Mattison.
2. MARKET
The difficulty of predicting what kids want was amply demonstrated in 1999, when Hasbro bet the bank on toys based on “Star Wars Episode 1: The Phantom Menace.” Despite the fact that the movie was a hit, Hasbro found itself with shelves of extra toys well into 2000. Sales of Pokemon-based toys also cratered.
“While sales ballooned to enormous proportions, demand was on a short fuse,” said Salomon Smith Barney analyst Jill Krutick. “They miscalculated.”
The good thing about kids, though, is that they always want toys of some kind, regardless of what GDP is.
“Historically we have not seen U.S. toy sales move with the economy,” said Williams. “Toy sales are driven more by products.”
The two giants — Mattel and Hasbro — make up almost 40% of the market. The rest is shared among various small players, none of which top 5% market share.
Toy sales were flat in 2000, as the post-Star Wars drop in action-figure sales and a dying fad in plush toys were offset by the scooter craze and gains among the very young.
The most controversial subject among analysts is whether children are growing up faster.
“There's a belief that kids are outgrowing . . . certain products more quickly,” Krutick explained. “(Mattel's) Barbie used to reach up to 11 or 12 years old; now at six or seven girls are off to other things. Some concur that's a factor, others not.”
Jakks' Berman does not.
“Kids are still kids,” he said. “Kids still play with crayons, kids still play with action figures. They are growing up quicker but they still are children.”
Yet this view drives strategies.
“If you look at Barbie, they changed the packaging and the shape of the doll in part to keep the audience at an older age,” Williams said.
3. CLIMATE
The industry consolidated rapidly in the 1990s. Mattel got Fisher-Price in 1993, Tyco Toys in 1996 and American Girl in 1998.
Not all buyouts worked. In 1999, Mattel shelled out $3.5 billion for The Learning Co., only to watch it bleed cash. Mattel sold it in October. The deal helped drive out CEO Jill Barad.
Licensing also drove up costs. After Hasbro lost money from a seemingly sure thing like Star Wars, the industry took a harder look at licensing fees.
“The implosion of those licenses certainly brought the cost issue to the forefront,” said Krutick. “Both (Mattel and Hasbro) had made a series of acquisitions over the years.”
After those moves, they've found themselves struggling to bring the break-even point down. Mattel recently said it'll close its last U.S. plant.
In the woes of the big players, however, smaller players see opportunity.
“(Retailers) still need to work with the Mattels and Hasbros, but they can't work with just them,” said Berman. “They need companies like Jakks Pacific, like Bandai, to provide them with alternative product. And profit.”
Analyst Jeffrey Thomison of Hilliard Lyons agrees.
“The giants have their attention divided up among many different issues,” he said. “Jakks, being the smaller company that it is, can set its sights more clearly, get things done more quickly.”
But Krutick says today is not especially a better time for small firms. “There have always been opportunities for new ideas,” she said. “Many of the biggest hits from the industry were developed by players other than Mattel and Hasbro.”
The problem for smaller players is getting more than one hit. For that reason, smaller players are still joining. Jakks' buyouts include colored-pen company Flying Colors and military toy maker 21st Century Toys.
4. TECHNOLOGY
Toys have been getting more high-tech along with everything else.
“Fisher-Price saw awesome growth last year by putting more technology in their toys,” said Williams.
Still, firms have to be careful. Krutick says Mattel and Hasbro struggled in the CD-ROM market for children, already dominated by tech firms.
“The market got saturated and pricing imploded,” she said.
Berman says firms can get in trouble if they let tech distract them from fundamentals. Jakks learned this the hard way when it developed audio files kids could download to get sound effects for Steve Austin figures.
“It was probably the worst item in the history of our company,” he said. “And it was probably the coolest item. But kids don't play with toys with the computer.”
A more successful tech connection for some companies is with PC games. With game characters becoming as big as TV and movie personalities, toy makers have a whole new licensing universe to draw from.
But as the scooter craze last year shows, children haven't lost their taste for low tech. Berman says one field enjoying a resurgence is crafts — old standards like pens, paper, crayons, scissors and glue.
5. OUTLOOK
The near future is murky, but analysts say Mattel and Hasbro are on the mend with new managers and a greater focus on core abilities. Some smaller firms are making inroads with innovative products and mergers.
Upside: Toys are hurt less than most industries by downturns, since they're mostly small expenses. Analysts say large players have learned from their mistakes and are not likely to spend so freely again.
Krutick says toy sales tend to follow the video-game cycle, which is set for a breakout in 2002. Williams says the new Harry Potter movie and the third Jurassic Park film this year may bring bonanzas of product tie-ins.
Risks: Toys are hit-driven, and it's impossible to predict who will come up with the next scooter. Takeovers carry the risk of costly failures.
Toy makers face unexpected recalls. Last year, Equity Marketing yanked Pokemon balls that could lodge in infants' throats.
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