Will a New Elmo Sell?

When it comes to manufacturing toys that can successfully capture a kid's attention for more than a few seconds, the bar is continually being raised. I have noticed that my old favorite -- Lincoln Logs -- isn't exactly afforded much shelf space at Toys "R" Us (NYSE:TOY) these days. And with blocks and marbles giving way to pentop computers and voice recognition chips, it's not surprising that old standbys like Barbie just don't seem to connect like they used to.

However, the company behind the timeless doll, Motley Fool Inside Value pick Mattel (NYSE:MAT), has just begun to actively roll out the next generation of another classic -- Knows Your Name Elmo. With the help of a CD-ROM and a USB cable, parents can program Elmo with pertinent information about their child -- name, birthday, favorite food, etc. Once he has made their acquaintance, Elmo can then incorporate many of his new friend's favorite things into dozens of songs, sayings, and stories. And an internal clock will even help ensure that his speech will vary according to the time of day.

Though he perpetually remains three years old, the popular Sesame Street character has grown up markedly since Tickle Me Elmo became the must-have sensation of the 1996 holiday season. At the time, I never really understood what all the fuss was about. My two-year-old son has given me a different perspective, though, considering he sleeps with two Elmo dolls, drinks out of an Elmo cup, and even dressed up as the furry red monster for Halloween.

While the interactive toy has actually been on store shelves for months, Mattel is hoping that Elmo can once again work his magic during the pivotal fourth quarter. Incidentally, the company has also released a Winnie the Pooh version with similar capabilities. According to the company, the response thus far from retailers has been "fantastic," and an equally enthusiastic reaction from holiday shoppers could help breathe new life into sales that desperately need a catalyst.

Over the last five years, Mattel has delivered annual top-line growth of around only 2%, and year-to-date revenues have edged up just 2.6% to $3.34 billion. Meanwhile, sales growth has been equally hard to come by at rival Hasbro (NYSE:HAS), though its revenues have bounced roughly 4% higher so far this year. Recently, its margins have weakened as Mattel deals with rising input costs. To combat the problem, management has scheduled steeper price hikes (following a 2% to 4% increase this year) in 2006, as well as a corporate restructuring aimed at trimming operating expenses.

Toy makers are facing a number of challenges, not the least of which is the fact that traditional toys are losing relevance in a world becoming more and more interested in electronic and video games. On an industrywide basis, toy sales slipped 3% last year to $20.1 billion and have fallen another 5% through the first three quarters of this year. Nevertheless, manufacturers are fighting back with ever more innovative products, and given Mattel shares' reasonable valuation and 3%-plus dividend yield, the recent drop in their price may help value hunters rediscover their inner child.

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Fool contributor Nathan Slaughter owns none of the companies mentioned.