Mattel: The Aftermath
Posted October 19, 2007 
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Like Paul Midler at www.thechinagame.com, I too was curious as to the financial impact of the recent product recalls on Mattel and expected it to be nothing short of catastrophic. While news from the company didn’t set off major alarms—the company’s third-quarter results included charges of about $40 million for recalls—the stock has in fact sold off from a high of near $30 per share in May of this year to just under $22 today, a 27 percent decline.
Nonetheless, the Street seems to think that this sell-off is overdone. Credit Suisse analyst Scott C. Barry’s view is that Mattel can still deliver strong margins, returns and free cash flow. “Recent recall-related issues have not altered our belief that Mattel is a 3 to 4 percent top-line grower with stable to improving margins that generates strong returns and prodigious amounts of free cash flow,” Barry wrote. “The recent share-price decline appears overdone, as we do not believe recall-related fallout will persist beyond the current holiday season,” Barry concluded.
With this conflicting data, I scratched my head, decided that this issue would require further investigation, and went on to more pressing matters. But Paul’s recent post, “Mattel: Knocked Down and Muzzled?” got me thinking some more about Mattel, toys from China and Christmas, so here are my current thoughts.
In a previous post, “China’s Toy Manufacturers Feel the Aftershock of Recalls,” I noted that a Chinese-language newspaper under the supervision of The People’s Daily (presumably a reliable source) had reported on September 13 that many of China’s small scale toymakers had already closed and that orders at the larger companies had been cut significantly. If this is in fact true, it raises some interesting questions. For instance, where are U.S. retailers going to get the toys to stock their shelves for Christmas? China reportedly accounts for 80 percent of toy production around the world, so if orders have been cut and Chinese companies have gone out of business, they won’t get nearly as many from China as in the past. To get to the U.S. by Thanksgiving and the start of the Christmas selling season, toys would have to leave China by mid-October at the very latest, leaving only one month for re-sourcing to more reliable Chinese companies or to companies located in other countries. While this might be accomplished in time for the 2008 season, it simply is not possible in such a short time frame for 2007. Santa and his reindeer may have an easier time of it this year with much lighter bags.
Moreover, anecdotal evidence suggests that consumer habits may change as a result of the “Made in China” crisis. How much it will change buying patterns over the long term is a matter of debate, but there is certain to be an impact this year. My oldest daughter, who has a one-year-old son and is at the peak of her toy -buying years, told me that she is already alarmed at the toys she has in the house, and vowed to take a close look at any toys that she or others might buy for her son this Christmas. Whether this crisis fades and her view changes in 2008 are a question mark, but I feel quite certain that she will buy differently in the coming months.
Meanwhile, a number of new toymakers are coming on the scene in the United States to fill the void and appeal to her concerns and those of others. The advertising slogans are not difficult to imagine: “Made in the Good Old US of A”; “No Lead Paint”; and “Toys Made With the Highest Quality Materials and Workmanship.” Perhaps all of these new entries will fail, but my guess is that an interesting niche where price is not as much of an issue has been created.
Bottom line: I think that we need to wait and see what story the fourth quarter numbers say, not only for toys but also for China exports. In my opinion, the jury is still out on all of this—the ultimate impact on Mattel as well as the ultimate impact on China.
