Does Mattel’s Purchase of MEGA Brands Contradict its Strategy?

Mattel (NASDAQ: MAT  ) acquiring another toy business might sound about as exciting as clean-up time. But shelling out $460 million in cash for Canada's MEGA Brands is no mismatch. By acquiring MEGA, Mattel gains a foothold in what's proven thus far to be an elusive construction-play market for the toy giant.

At the heart of Mattel's acquisition is its entry into the toy construction segment dominated by No. 1 Lego, whose sales in 2013 jumped 10% to $4.6 billion, and No. 2 MEGA Brands, with annual sales eclipsing $400 million.  Mattel has primarily been watching from the sidelines, with not even a 1% share. And while tablets and game consoles may have changed the rules, kids still play with traditional toys. 

"Parents love the construction category," Jim Silver, CEO and editor in chief of TTPM, a consumer website featuring toy product reviews, videos, and price updates, told me. "It has a very high perceived value with parents because you can play over and over ... build different concepts and create story lines. And kids enjoy it. These toys stay in the house for many years." 

Silver touted the deal as inevitable in light of a partnership already in place between the toy brands. But in other ways the deal seemed to come out of left field and clashes with what Mattel had painted as a picture of content-driven growth.

The toy industry hit a rough patch in 2013 amid a series of headwinds ranging from harsh weather to the absence of blockbuster films from which to drive sales of toy-related merchandise. It's possible that the deal with MEGA Brands is Mattel's attempt to regroup, a Plan B if you will. That theory might not be that far fetched. As Goldman Sachs analysts recognized, the acquisition seems to contradict Mattel's other strategy. 

[T]his further entrenches [Mattel] into traditional toys, in contrast to its stated goal to become more character and content driven. -- Goldman Sachs report

Mattel execs on the conference call about the deal responded to such claims defensively:    

When we talk about creating content, I think I have always said we're not an entertainment company. We don't want to be an entertainment company. -- Bryan Stockton, Mattel CEO

Nevertheless, Mattel has some pretty close ties with the folks who do.

Licensing wars  
Mattel has license and distribution agreements with the likes of Walt Disney that grant the toy company access to characters like Mickey Mouse and the cast from from Cars. These partnerships prove especially lucrative during years of major studio releases; and as Silver pointed out to me, Planes: Fire & Rescue, a Cars spinoff, is set for release in July. 

Now the acquisition isn't too far removed from those partnerships, as it presents Mattel with the opportunity to incorporate the characters onto the MEGA Brands platform. And on the content side, perhaps Mattel can strengthen its partnership with Netflix, where the toy maker recently launched Team Hot Wheels programming.

That wouldn't be a bad idea, especially in light of the fact that Lego becomes more of a direct competitor to Mattel amid the MEGA Brands acquisition. Lego recently partnered with Twentieth Century Fox for licensing rights to the Simpsons brand; that deal includes forthcoming Lego/Simpsons television programming in May. 

Lego similarly has a licensing deal with Disney. But MEGA just inherited megascale with its new owner. If it came down to it, Disney may opt to side with Mattel and MEGA over Lego for the licensing rights to Cars

Mattel's own financial performance has been suffering of late, particularly in the U.S. North American gross sales fell 2% last year and overall net sales of $6.5 billion represented a meager 1% increase versus 2012.

By adding MEGA Brands, Mattel expects to bolster its top line. Of MEGA Brands' $400 million in annual revenue, nearly three-quarters is generated by construction toys. And with the addition of RoseArt, MEGA's arts and crafts brand, Mattel can celebrate Christmas twice per year. In addition to the obvious holiday season, the summer months will take on a whole new meaning.

"July is the slowest month for toy sales, mid-July to mid-August. That season is booming for back to school sales. This puts [Mattel] into competition for the back to school market and it can bring huge sales at [an otherwise] dormant time of year," Silver told me. 

So the acquisition of MEGA Brands tucks neatly into Mattel's portfolio. But not without some hurdles. 

Deal headwinds
MEGA will continue to operate independently out of its Montreal facility, a high-cost region in which to do business, as pointed out by Goldman analyst Michael Kelter. And the Canadian company has been suffering from below-average operating margins. In Mattel's quest to engineer higher margins at MEGA, it plans to heavily invest in marketing activities, which threatens to slow the results. For the deal to work and to be more efficient, perhaps Mattel should entertain the possibility of relocating MEGA's home base closer to its home in Southern California. 

Conclusion 
Whether it was kismet or a Plan B that brought Mattel and MEGA Brands together, the deal awaits shareholder approval. One thing is clear -- there's no turning back or Mattel will be hit with a hefty $12 million breakup fee.

The next step for you
Want to profit on business analysis like this? The key for your future is to turn business insights into portfolio gold through smart and steady investing ... starting right now. Those who wait on the sidelines are missing out on huge gains and putting their financial futures in jeopardy. The Motley Fool is offering a new special report, an essential guide to investing, which includes access to top stocks to buy now. Click here to get your copy today -- it's absolutely free.


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2883420, ~/Articles/ArticleHandler.aspx, 10/24/2014 6:44:51 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Apple's next smart device (warning, it may shock you

Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


Advertisement