Credit Woes Derail Thomas the Tank Engine

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Children's books were going to be the catalyst for change at toy maker RC2 (Nasdaq: RCRC), but since the credit markets seized up, that transformation is going to have to come in a later chapter. A $163 million deal to buy the Children's Publishing Division from privately held Publications International fell through after the maker of the Thomas & Friends line of toys said there was simply no capital available to make it happen.

RC2 isn't the only buyer on the market to have a merger collapse because of a dearth of credit. While we read about Bank of America (NYSE: BAC) or Citigroup (NYSE: C) still making megamergers to save various financial assets, the capital markets have shrunk to such a degree that many deals are falling by the wayside or not taking place altogether.

Mining company Xstrata just backed out of a $10 billion deal to buy Lonmin, and Apollo Capital Management tried to back out of buying Huntsman (NYSE: HUN), though a court ruled it must complete the deal. In fact, through the first nine months of the year, global deal volume has declined 23% to $2.6 trillion. And private equity has essentially dried up; such deals are down 72% so far this year, to $177 billion.

The arid credit landscape comes at a particularly difficult moment for RC2. Revenue fell 4% in the toymaker's second quarter as it posted a $0.37-per-share loss. While the quarter is typically a slow one -- 60% of RC2's sales come in the second half of the year -- it also suggests that the next two quarters aren't going to be particularly robust. That's why a lot had been riding on the acquisition. With $112 million in annual sales last year and operating margins in the mid-teens, it was expected to be immediately accretive to earnings.

It was also going to be going up against some pretty weak comparables. Last year, sales had fallen as a result of two product recalls, which occurred at the same time as consumers began reining in their discretionary purchases. Plus, the Children's Publishing purchase would have been a nice fit with the company’s pre-school and toddler products.

RC2 will probably receive some benefits from the declines in prices we've seen in commodities and fuel costs, along with a strengthening of the dollar against many major currencies. The toy maker says it has not closed the book completely on making the acquisition, that it might revisit it if there's a thaw in the credit markets. Yet at 12 times expected earnings, that's putting it at a level comparable to Mattel (NYSE: MAT) and just a little beneath Hasbro (NYSE: HAS), both of which have better prospects ahead.

With the coming holidays not expected to bring much cheer to retailers, I wouldn't look for RC2 to write many new chapters on growth anytime soon.

Read chapter and verse with these related Foolish articles:

• RC2 tries to keep its head above water.
• Once upon a time, RC2 made money.
• Every day is Christmas for some toy makers.