Date: November 27, 1996

location: Mount Laurel

Title: Mattel Snaps Up Tyco Toys for $775 Million

Author: Martin Daks

Subject: Years of losses set the stage for the New Jersey company to be taken over by the California one. Now the future of 400 jobs here is in question.

It could have been a scene out of Hollywood. The prim and proper blonde-haired, blue-eyed young lady falls in with a hot-rodding crowd and roars off to unknown adventures.

It could have been Hollywood, but instead it was Wall Street. On November 18 Mattel, which is based in El Segundo, Calif. and is best known for its pristine Barbie dolls, announced it had reached a $775 million stock agreement to buy Mount Laurel-based Tyco Toys, the maker of radio-controlled hot rods, Sesame Street toys and other products. The companies plan to do the sale as a tax-free pooling of interests. If shareholders and regulators approve, the ranks of the Big Three toymakers–Mattel, Hasbro and Tyco Toys–will thin to just two.

Even as the deal was being celebrated, however, there were some complications. First questions were raised about trading patterns in call options for Tyco Toys stock just prior to the announcement. The option trading activity surged more than threefold during the week before Mattel”s offer was announced, indicating that some investors must have known about the acquisition in advance. They bought call options, locking in a $7.50 per share price for one month. When Tyco Toys” stock rose to $11.38 as of November 20, they stood to make a bundle.

Similar activity occurred in January when Mattel made an aborted bid for Hasbro, the No. 2 toy maker. The Securities and Exchange Commission investigated the Hasbro option activity but has not yet released any findings or conclusions. Regulators, as always during an investigation, have no comments about the Tyco Toys options.

Then Tyco Toys” preferred stockholders raised an unexpected problem. They fear the loss of an 8.25% annual dividend if, as planned, their preferred shares are converted to common stock as part of the Mattel buyout. A Mattel spokesman says the company is “prepared to do whatever is necessary” to complete the merger. The odds are that niether complication would kill the agreement.

The Mattel-Tyco deal caps three years of turbulence at Tyco Toys. Its market share and bottom line tumbled when sales of its fad toys–lines built around popular television and movie characters like Ariel the mermaid–dropped when fickle children moved on to other heroes.

Tyco Toys President Gary Baughman, 49, who took over the company in October 1994 moved decisively to contain the company”s costs and shore up sales. Tyco Toys shed 135 employees worldwide and redirected its focus towards Matchbox cars and its other proven sellers. The firm ran up $9 million in restructuring charges as it tried to make itself over, and a June stock offering raised $96 million, which was used to help pare debt and pay for the restructuring and expansion efforts. But the sale of the company to Mattel in many ways was an admission that Baughman”s turnaround efforts failed.

Tyco Toys, of course, puts a different spin on it. “This is a very positive development for Tyco shareholders,” says Baughman. “We have successfully emerged from some difficult years and are now pleased to become part of such a dynamic and exciting company as Mattel.” Tyco Toys, which had revenues in 1995 of $709 million, will represent a small but significant part of Mattel”s $3.6 billion annual sales.

When Baughman says Tyco Toys emerged “from some difficult years,” he is talking about the firm”s three years of losses, which totalled more than $130 million by December 31, 1995. Tyco Toys, though, claimed it had successfully turned the corner recently with net income of $9.6 million for the quarter ended September 30. That was more than double the previous year”s third quarter profit of $4.7 million.

But the impressive results do not tell the whole story. When the year-to-date results are tallied, Tyco Toys shows a net loss of almost $6 million. Clearly the company was not yet out of the red.

Given the three years of losses that threatened to stretch into a fourth year, observers might question Mattel”s willingness to pay $12.50 a share for a firm that commanded only $6.38 a share at the beginning of November. The answer may lie in the combination of Mattel”s international distribution system and Tyco Toys” products.

Overseas sales have traditionally been Tyco Toys” weak suit. European and Asian markets beckon U.S. firms, but in the pre-Baughman days a costly, decentralized European network was a drag on Tyco Toys” operations. A shakeup replaced the sprawl of European offices with one centralized site in Belgium, but the cost savings could not rescue the operation. Tyco Toys” overseas sales just did not grow enough to be viable. While 40% of Mattel”s sales are generated outside the U.S., Tyco Toys” overseas activity never rose above 25% of total sales.

Mattel saw a lucrative opportunity to expand by combining its strong distribution network with Tyco Toys” products. This approach saves Mattel the startup costs associated with developing new toys and building brand awareness. It will save Tyco Toys the time and money required to revamp its distribution operation.

The deal may also help Barbie get over the sorrow left from an earlier affair. In February Mattel was rebuffed in its $5.2 billion bid for Hasbro amid antitrust concerns. The Tyco Toys-Mattel combination is expected to hold about a 19% share of the $13 billion U.S. toy market, which should keep it beneath the antitrust radar.

Neither company is publicly speculating about the future of Tyco Toys” Mount Laurel employees, although insiders say the combined firm will be run from Mattel”s California headquarters. Past experience gives no comfort to Tyco Toys employees. In January 1994 more than 10% of toymaker Fisher-Price”s East Aurora, N.Y. employees were terminated after Mattel took over the company. The ax swung again in December 1994, after Mattel acquired two other firms. About 1,000 Mattel jobs, representing 4.5% of its workforce, were cut worldwide. Said Mattel Chairman John W. Amermann at the time: “While corporate restructuring is often seen only during difficult times, this action comes as we anticipate reporting record results for the sixth consecutive year.” In a recent interview, Tyco Toys” Baughman said he”s not sure whether he will have a job after the buyout is completed.

“There are always corporate integration issues,” says Madeline Mamaux, the associate director of Fitch Investors Service in New York City. “It”s complex–the companies themselves may not yet be sure what will happen.” The integration question prompted Fitch to drop its Mattel rating a notch, from positive to merely stable.

The Mattel-Tyco Toys merger appears to be a good business move. But Tyco Toys” Mount Laurel headquarters will almost surely be downsized, if not eliminated, and up to 400 New Jersey employees face a questionable future.

The culprit, though, is not high labor rates or low productivity. Instead the state is feeling the effect of corporate consolidation, as the two firms jockey to reach economies of scale. Companies from accounting firms to utilities are merging to pool their resources and meet the demands of global competition. As Tyco Toys found out, companies that can”t keep up with the leaders are soon out of the race.