Turmoil in Toyland

The demise of Toys “R” Us is hitting toy makers and clearly separating the weak from the strong.

The chain, which is liquidating its U.S. stores and considering the fate of its Asia and Europe operations, was a major driver of the $27 billion industry. Its 50,000 square-foot stores were cathedrals to play, places where children explored and discovered new toys. General merchandise retailers like Walmart or Target simply don’t have the space for that.

Last week both Hasbro HAS 1.81% and Mattel MAT 1.36% posted declining sales and losses for the first quarter. Lost sales from Toys “R” Us were partially to blame, but the companies also held back products from competing retailers, which would have been tempted to match the liquidating chain’s hugely discounted prices.

Toy manufacturers are in “self-preservation mode,” says Stephanie Wissink, an analyst at Jefferies LLC. “They’re protecting their brand equity so they don’t get tangled up in a price erosion they can’t unwind,” she added.

On Thursday Mattel, maker of Barbie dolls, American Girl dolls, Fisher-Price, and Hot Wheels toys, had a loss that was almost three times bigger than the same period last year. Revenue also fell to $708.4 million from $735.6 million a year ago, though it beat expectations.

Hasbro, which owns Transformers, My Little Pony, and the rights to Disney franchises “Frozen” and “Star Wars,” and has a market value more than twice as big as Mattel’s, suffered too. In the U.S. and Canada, sales fell 19%. (It was comparing against a very strong period last year, whereas Mattel was comparing against a very weak one.) The company reported a first-quarter loss of $112.5 million or 90 cents a share, and revenue dropped to $716.3 million.

Yet the disruption is likely a transitory one. Other retailers, including Amazon.com , are rushing to take Toys “R” Us’s market share and increase their toy offerings. Meanwhile, manufacturers are building out their e-commerce capabilities, which have lagged behind. Only about 20% of Hasbro’s sales occur online.

Of the two manufacturers, Hasbro is far better positioned to evolve with the industry. Unlike Mattel, Hasbro isn’t constrained by debt and it has more continuity and stability in its management team, which has been together for eight years. Mattel, which recently named a new CEO, has seen several abrupt pivots in leadership. It also has debt coming due beginning next year.

With a debt-adjusted market value about 50% higher than Mattel’s, Hasbro is the more expensive stock. But it has options and that is what the market values. One might be to take over Mattel. An offer it made last fall came to nothing. The timing may be right to revive that discussion. At its current level, Mattel is ripe for the taking.

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