Assessing critical mass

Over the last several years, merger activity in the toy and collectibles industry has slowed—not surprising given the overall economic climate. In 2002, there were 15 reported merger and acquisition transactions in the toys and collectibles industries, representing just $83.1 million in disclosed value.

In contrast, over the past five years there has been a sum of 89 transactions for a total disclosed value of $1.7 billion. This translates into an average of 18 transactions per year and $344.5 million in annual transaction value.

It is likely that this decline in the number and value of transactions over the past five years reflects a shifting emphasis on the part of the industry to strategic value and effective integration, from critical mass.

But critical mass is still important. Now, though, it is simply one of a number of factors that are given consideration in the decision to acquire a company. This trend is also indicative of the toy manufacturers' reluctance to undertake break-the-bank transactions; the risk of making a mistake in a tough market is simply too great for many companies.

Going forward, consolidation within this fragmented industry is expected to continue, with a premium placed on those transactions that offer meaningful revenue synergies and cost-saving opportunities at "reasonable" prices.

The recent acquisition by Racing Champions Ertl of Learning Curve fits into this emerging pattern, bringing both significant synergies and strategic benefits to the new company, RC2 Corp.

As RC2 Corp.'s sole financial advisor involved in structuring each of these transactions, Robert W. Baird & Co. is in a position to evaluate what made these deals work, and what factors other firms in the toy industry should consider before embarking on a similar course.

In analyzing potential acquisitions, companies need to look broadly at the impact a transaction would have on three areas: products, distribution and licenses. In the case of Learning Curve, the company had something positive to offer Racing Champions in all three categories: Its product offering was clearly complementary. Prior to the acquisition, RC2 Corp. was primarily a manufacturer and marketer of collectibles, offering high quality, die-cast replicas of motor vehicles from agricultural, construction, outdoor sports, high performance and racing. Plus, its "typical" customers were adult male collectors.

The Learning Curve acquisition immediately broadened the product line, bringing preschool brand name strength to the combined company. The combined company's product offering now spans from preschool to adult.

Since the close of the transaction, RC2 Corp. has moved to leverage these synergies and anticipates the transaction to be accretive to earnings during the first year of operations. The end result is expected to be a combined entity with a broader product offering, a more diverse license portfolio, and a greater distribution channel depth able to compete more effectively than either company could have managed on a stand-alone basis.

Size does matter in the toy business, and the combination of Racing Champions Ertl and Learning Curve is expected to provide the kind of scale necessary for RC2 Corp. to compete with Mattel, Hasbro and other major manufacturers. The combined entity is seen by its principals to be able to more effectively compete for both attractive new licenses and for shelf space with distributors and retailers.

At the same time, corporate officials believe the company will be well positioned to make the technology investment required to keep pace with the increasing demands of large retailers.

All this is increasingly important in today's challenging environment, where vendor rationalization is a fact of life and product innovation is a "must," given ever-changing consumer preferences.