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Mattel (NYSE: MAT) is the world’s largest toy manufacturer with over $5.9 billion of net sales in 2008.^[1] Mattel makes some of the best known brands in the toy industry, including Barbie, Matchbox, Fisher-Price and Hot Wheels. Being the world's leading toy company, Mattel faces the full brunt of the slow-growing industry. Traditional toys have suffered at the hands of the fast-growing video game industry as children increasingly prefer to spend their time and parents' money on digital entertainment.

In addition to the threat from video games, profit margins at Mattel and other traditional toy manufacturers are being squeezed by macro-economic factors largely out of their control, including pressure from retailers and rising input and distribution costs.^[2] The retail landscape for toys has shifted and specialty retailers such as Toys'R'Us and FAO Schwartz are slowly adopting to the shift in childrens' entertainment towards video games. Behemoth discount retailer Wal-Mart (WMT) is currently the largest retailer of children's toys in the U.S., a shift which has pressured Mattel's margins as Wal-Mart demands low prices from its suppliers. Exacerbating matters, since the U.S. recession began in late 2007, retailers have been struggling to move product.^[3] Additionally, fluctuations in oil prices affect input costs for making plastic-based toys as well as distribution costs for transporting products from factories in Asia to other parts of the world.

On the positive side, Mattel entered the electronic game industry through its acquisition of Radica Games in October 2006.^[4] Mattel has also continued to grow its portfolio of traditional toys, by adding licensing contracts with WWE Wrestling and HIT Entertainment.^[2]

Company Overview

Mattel designs and manufactures a wide-range of toy and entertainment products, most of which are sold through third-party retailers, with the remainder being sold in a handful of Mattel's own retail outlets. Mattel's products include dolls, board games, outdoor play equipment, electronic games and a variety of other merchandise targeted primarily for children. Some of Mattel's electronic and board games are designed for an older customer, from teenagers to adults. Mattel markets its products throughout the world, with nearly half of its sales coming from outside the United States.^[5]

Business and Financial Metrics

Mattel Net Sales and Income^[1][5] Mattel's net sales fell in 2008 as the U.S. recession weighed down consumer spending on unnecessary items such as toys.

• In 2008, Mattel received over $5.9 billion in net sales, down 1% from 2007,^[1] largely due to falling consumer spending during the U.S. recession.^[3]

• Mattel's revenues have grown at a CAGR of 3.7% since 2004, when total revenues were $5.1 billion.^[1][5]

• Gross margin has fallen from 49.0% in 2003 to 45.4% in 2008, due to a combination of price pressures from retailers and increasing input and distribution costs related to commodity and oil prices.^[1][5]

• In 2007, Mattel's reputation took a major hit when the company recalled 967,000 toys due to issues with lead paint in the products. The firm stopped two-thirds of the products from reaching consumers, but over 300,000 items were bought by consumers in the United States.^[6] The products were manufactured by a Chinese sub-contractor but several lawsuits have been brought against Mattel for the incident, in addition to masses of bad press.

Business Segments

Mattel groups all of its products into three major brand groups:

• Mattel Boys & Girls Brands (56% of sales)^[1]: This segment includes most of Mattel's traditional products and licensing agreements from other companies such as Disney (DIS), Time Warner (TWX), and DC Comics. The Girls brands include: Barbie, Polly Pocket!, and Disney Classics. The Boys brands include: Hot Wheels, Matchbox, Tyco R/C brands, and licensed DC Comics products such as superhero action figures. This category also includes Radica Games, an electronic game maker acquired by Mattel in 2006. This segment experienced a 2% decline in gross sales during 2008.^[1]

Mattel Sales by Brand^[1] Mattel's largest brand group, Boys & Girls Brands, experienced a 2% decline in sales in 2008, while sales for the smallest group, American Girl Brands, grew 7%.

• Fisher-Price Brands (37% of sales)^[1]: This segment includes products designed for younger children. The core brands within this category include: Fiscer-Price, Little People, BabyGear and View-Master. The Fisher-Price segment also includes licensed products from Nickelodeon (Dora the Explorer and Go-Diego-Go), Sesame Street, and Disney (Winnie the Pooh). Gross sales for the Fisher-Price group increased 1% worldwide during 2008.^[1]

• American Girl Brands (7% of sales)^[1]: American Girl operates as a subsidiary of Mattel and sells most of its products directly to customers exclusively in the U.S., although Mattel operates a handful of American Girl doll retail stores throughout the country. American Girl products include a range of dolls, books, clothes, toys, and accessories for girls aged 3 and up. American Girl sales increased 7% in 2008,^[1] largely driven by the summer 2008 release of the film Kit Kittredge: An American Girl which led to increased sales of dolls and products related to the movie.^[2]

Geographic Sales

Mattel divides its business into two primary sectors: Domestic/North America and International. Mattel products are sold directly to retailers in most European, Latin American and Asian countries; in Australia, Canada and New Zealand, its products are sold through agents and distributors (Mattel has no direct sales presence). Except for American Girl, which is not sold internationally, Mattel offers the same products in both domestically and abroad. It does tailor product mix to regional fads and the quality is varied due to price sensitivity.

Mattel's international sales accounted for 49% of its gross sales in 2008.^[1] Europe, which accounted for 27% of 2007 sales,^[7] is Mattel's largest market outside of North America. In 2008, domestic sales fell 2% while international sales were only down 1%, as sales in each region differed: Europe (-6%), Latin America (+7%), Asia Pacific (+4%).^[8][2]

Trends and Forces

Video Games vs. Traditional Toys

Toy sales in the U.S. have been growing at a very low rate for the last few years. In fact, in 2008 toy sales in the U.S. fell 3%.^[9] This is mainly because of the shift from traditional toys towards video games. In 2008, sales of video game software units (actual games as opposed to consoles) grew 15% in the United States and 26% in the United Kingdom.^[10]

Mattel's 2006 acquisition of Radica is the company's attempt to tap into the potential in the digital gaming industry, but Radica produces handheld electronic games (such as electronic devices that offer games such as 20 Questions, Checkers, etc) while the major growth in electronic games is in console gaming (Sony's PlayStation3, Microsoft's Xbox 360 and Nintendo's Wii). Without a major foray into video gaming, Mattel could stand to lose significant market share as youth turn to digital entertainment over traditional toys.

Importance of Oil Prices

A considerable amount of Mattel's manufacturing cost comes from plastic resin, which accounts for approximately one-quarter of cost of goods sold. In recent years, resin prices have soared because of a rise in prices of its key component: petroleum. Oil prices skyrocketed in 2007-2008 before peaking in August 2008, when price began to fall drastically. These price movements caused the price of manufacturing plastic-based toys rise considerably in 2008, hurting Mattel's profit margins (gross margin down to 45.4% in FY08 from 46.5% in FY07)^[1][5], but if the price of oil remains low, Mattel's costs would be significantly lower in 2009 allowing the firm to earn higher profit figures. This effect is augmented because oil prices play a primary role in Mattel's distribution costs related to transporting its products from manufacturing plants in Asia to customers and retailers around the world. Conversely, a return to rising oil prices would put downward pressure on Mattel's profit margins.

^[11]

Changes in Toy Retailing

The toy retailing environment has changed greatly in recent years. Specialty retailers such as Toys'R'Us and FAO Schwartz have faced difficulty in the current decade. The latter has already been in and out of several bankruptcies and Toys'R'Us has flirted with bankruptcy. Part of this change has been driven by the slow growth of the traditional toy market and the rapid rise of video games, a category that toy stores were slow to adopt. Instead, the video game market became dominated by electronic retailers such as Best Buy (BBY). Mattel's sales to Toys'R'Us decreased in 2007 to $0.7 billion from $0.8 billion in 2006 as the firm cut down on its purchases.

Compounding the woes of toy stores is that growing dominance of large discount retailers such as Wal-Mart (WMT) and Target (TGT), both of which have captured a significant chunk of both the traditional toys market and the video game market. Mattel's three largest customers (Wal-Mart, Target and Toys'R'US) accounted for approximately 41% of sales in 2007,^[5] giving the three firms considerable leverage over Mattel when negotiating prices.

This has become increasingly pertinent as the U.S. entered a recession in late 2007 and retailers have had to drop product prices to counter a decline in consumer spending on unnecessary purchases, such as toys.^[3][9] This adds to the pain of falling unit sales by lowering the revenue Mattel earns on each sale.

Competition

Mattel is the largest manufacturer of toys in the world in terms of revenue, with $5.91 billion in 2008 revenue.^[1] Its primary competitor is Hasbro (HAS), which received over $4.0 billion in 2008 revenue.^[12]

• Hasbro: The manufacturer of major toy and game brands such as Monopoly, Mr. Potato Head and Transformers. Mattel and Hasbro have different core segments -- Hasbro makes a large of portion of revenue from board games (Clue, Monopoly and Scrabble) while Mattel’s core business is dolls (Barbie). On the other hand, the two companies compete head-to-head over certain segments, as Hasbro's Playskool goes after the same younger audience as Mattel's Fischer-Price division.

• JAKKS Pacific (JAKK): A smaller toy manufacturing company, with licensing deals with Nickelodeon's Blue Clues, Disney's Hannah Montana and WWF Wrestling, among others. JAKKS Pacific is considerably smaller than Mattel, with less than $1 billion in 2008 revenue, but could become stronger with more licensing deals.

Secondary competitors of Mattel include LEGO (toy brick building sets), Bandai (Japanese action figures and video games) and video game manufacturers such as Electronic Arts (ERTS), Microsoft (MSFT), Sony (SNE), Atari (ATAR) and others. However none of these companies compete directly in the toy market for the same demographic of customer as Mattel.

References

1. ↑ ^{1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07 1.08 1.09 1.10 1.11 1.12 1.13 1.14 1.15 1.16} Mattel (MAT) 2008 Financial Exhibits
2. ↑ ^{2.0 2.1 2.2 2.3} Mattel (MAT) Earnings Call Transcript Fourth Quarter 2008
3. ↑ ^{3.0 3.1 3.2} WSJ.com, "NBER Makes It Official: Recession Started in December 2007", December 1, 2008
4. ↑ Mattel to Acquire Radica
5. ↑ ^{5.0 5.1 5.2 5.3 5.4 5.5 5.6} Mattel (MAT) Annual Report 2007, Selected Financial Data, pg. 37
6. ↑ New York Times "Lead Paint Prompts Mattel to Recall 967,000 Toys", August 2007
7. ↑ Mattel(MAT) Annual Report 2007, Geographic Information, pg. 117
8. ↑ Mattel (MAT) Press Release, "Mattel Reports 2008 Financial Results"
9. ↑ ^{9.0 9.1} NPD Group, "U.S. Toy Industry Sales Generate $21.64 Billion in 2008"
10. ↑ NPD Group, "2008 Video Game Software Sales Across Top Global Markets Experience Double-Digit Growth"
11. ↑ Historical Crude Oil Prices
12. ↑ ^{12.0 12.1} Hasbro (HAS) Press Release, "Hasbro Reports Full-Year Results and Eighth Consecutive Year of E.P.S. Growth"
13. ↑ JAKKS Pacific (JAKK) Press Release, "JAKKS Pacific Reports Fourth Quarter and Year-End Results for 2008"