Mattel Finds its Answer to LEGO

Mattel is buying MEGA Brands, which makes MEGA Bloks a more powerful competitor to LEGO.

Mar 1, 2014 at 10:11AM

With its hit movie, sales that grew 13% in 2013, and an eternally popular product, privately held LEGO has been very good at defending its piece of the toy universe. The company is about to see a stronger challenge from a competitor, however, as Mattel (NASDAQ:MAT) has reached a deal to buy MEGA Brands -- maker of a line of blocks very similar to LEGO's.

What is Mattel buying?

MEGA Brands owns a number of toy brands, including MEGA Bloks (a LEGO competitor/knockoff), Rose Art art supplies, and the lesser-known MEGA Puzzles and Board Dudes. The true prize of  the deal is MEGA Bloks -- which has products that match both the traditional LEGO line and its DUPLO brand for little kids. The company also has licensing deals to make MEGA Bloks sets based on properties including Halo, Skylanders, Call of Duty, Assassin's Creed, Power Rangers, Hello Kitty, and SpongeBob SquarePants.

In the third quarter -- the most recent one for which the Canadian company has reported results -- its consolidated net sales were $140.9 million compared to $140.1 million in the corresponding 2012 period. For the nine-month period ended Sept. 30, 2013, consolidated net sales increased 4% to $303.5 million compared to $292.7 million in the same period last year, the company reported.

How much did Mattel pay?

Mattel is paying approximately $460 million to buy MEGA Brands, according to a press release.

"The acquisition advances Mattel's global growth strategy of building upon its world-class portfolio of brands by expanding into two of the fastest-growing toy categories. MEGA Brands, a family of leading global brands, is the No. 2 player in the $4-billion construction building sets category with its MEGA Bloks brand as well as a competitor in the $2-billion arts & crafts category," said the Mattel press release.

MEGA had EBITDA of $38.1 million in the first three quarters of 2013 compared to $35.2 million in the corresponding period in 2012.The company estimates that it will have net sales for 2013 of $405 million. MEGA Brands' CEO believes that Mattel should be able to increase sales and market reach for the company's brands.

"Mattel is the ideal partner to take our brands to the next level," said Marc Bertrand, MEGA Brands president and CEO in a press release. "We are confident Mattel's scale and global platform spanning 150 markets -- combined with the expertise of our people in the construction and arts & crafts categories -- will create tremendous growth opportunities for our brands."

Mattel's boss is also confident that the deal makes sense for his company.

"A key pillar of our global growth strategy is the strategic acquisition of brands that will both benefit from our scale and help extend our reach into new and growing categories," said Bryan G. Stockton, Mattel Chairman and CEO. "The construction play pattern is popular, universal, and has had one of the fastest growth rates over the past three years. We look forward to helping MEGA Brands accelerate its global growth, providing more choices for more children and their families."

Is MEGA as good as LEGO?

Having spent two years as general manager of a giant independent toy store (over $2 million in annual sales), I have experience purchasing both LEGO and MEGA. Both make good products, though all of the LEGO line is high-end and some of the MEGA Bloks packaging can be a little crummier. Still MEGA's licensed lines are well done and comparable to LEGO's. In general they are also priced better with higher margins for independent stores.

MEGA wants new customers and generally offered flexible payment terms (to accounts with good credit), attractive pricing for large buys, and even more deals if you bought multiple lines from them. LEGO does none of that because it doesn't have to.

LEGO makes independent toy stores place an order for the entire year at one time for monthly delivery (though you can set what months you want things delivered). Ordering something does not guarantee the company will make it or deliver one to you -- but it gives you a shot and we usually got around 80% of what we ordered.

During the rest of the year LEGO sends independent stores a list of what sets it has available. Those can be purchased on a first-come, first-served basis and payment terms are always strict. LEGO is a giant that does not need independent stores and can offer them low margins (30%-35% whereas toys in most cases are 50% for independent stores buying well).

It always felt to me that MEGA wanted my business and LEGO did not (though the store I ran spent in the neighborhood of $100,000 per year with them). The problem is that even when MEGA had an excellent product, customers did not buy them the way the bought LEGOs. Yes, certain branded lines like Halo did OK, but especially around the holidays it was impossible to keep LEGO in stock, which was not the case for MEGA Bloks.

Can Mattel make MEGA bigger?

MEGA is a successful brand despite being a minor player compared to LEGO. Having the power of Mattel behind it should help it get places on more store shelves both in the United States and around the world. What Mattel will have a harder time doing is making MEGA not feel like R.C. Cola to Lego's Coke. The same is true for the Rose Art brand, whose art supplies are closer to store brand cola versus Coke when you compare them with Crayola.

There is room to grow for MEGA/Mattel through efficiencies of scale and improved sales channels. But taking down LEGO -- which has become an iconic brand -- is a tall order and something that is unlikely to happen anytime soon. Still MEGA Bloks could become Pepsi to Lego's Coke, even it's a very distant second.

Daniel Kline has no position in any stocks mentioned. The Motley Fool recommends Mattel. The Motley Fool owns shares of Mattel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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