Mattel Group Equity Valuation Jeremy Gilbert Angela Gorczyca Michael Innerebner Erin ...

58 Pages·2005·1.05 MB·English

Mattel Group Equity Valuation
Jeremy Gilbert
Angela Gorczyca
Michael Innerebner
Erin Kunselman
Andrew Mead
Mattel Valuation
T A B L E O F C O N T E N T S
Executive Summary..................................................3
Business & Industry Analysis...................................6
Industry Analysis.............................................................6
Five Forces Model...........................................................7

SWOT Analysis...............................................................9
Competitive Strategy Analysis.....................................10
Accounting Analysis................................................11
Accounting Analysis Steps...........................................11
Screening Ratios............................................................16
Ratio Analysis & Forecast Financials......................17
Financial Ratio Analysis................................................17
Cross Sectional (Benchmark) Analysis.......................20
Financial Statement Forecasting Metholdology........27
Valuations Analysis..................................................32
Method of Comparables...............................................33
Free Cash Flow & Discounted Dividends.................34
Discounted Residual Income.......................................39
Long Run Residual Income.........................................40
Abnormal Earnings Growth........................................41
Appendix..................................................................44

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Executive Summary
Executive Summary

MAT Mattel, Inc. (NYSE)
Date: December, 2004 Industry: Recreational Products
Business Summary: Mattel is one of the leading toy manufacturers and sellers in the world. Producing
hundreds of thousands of toys each year, Mattel has earned five billion dollars in revenue last year (2003) and
4.9 billion the previous year (2002). Some of Mattel’s well-known products include Barbie, Hot Wheels, Fisher
Price and American Girl toys.

Share Performance

Price: (current) $18.65 52 Week High: $20.50
Volume (millions): 3,879,200 52 Week Low: $15.94
Market Cap 7.7B Shares Outstanding 414.9670M
Dividend $.45 Yield 2.37%

Financial Snapshot (2003) Liquidity Ratios
Revenue $5.0B Current Ratio 1.63
Total Net Income $537.6M Quick Asset Ratio 1.16
Earnings Per Share $1.22 Inventory Turnover 6.51
EBITDA $1.0B A/R Turnover 9.12
Long Term Debt $589.1M Working Capital Turnover 5.35

Valuation Predictions Profitability Ratios
Free Cash Flow $19.43 Gross Profit Margin .49
Discounted Dividends $19.24 Operating Expense 20.22
Long Run Residual Income $19.30 Net Profit Margin .11
Residual Income $22.33 Asset Turnover 1.10
Abnormal Earnings Growth $22.69 Return on Assets .12
Return on Equity .24
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Executive Summary

A
s stated previously, Mattel is in the business of manufacturing and selling
toys. We have discovered that the toy industry is both highly competitive
and highly lucrative. There is a high rivalry factor with a low threat of
new entrants, which means that there are a few main competitors that fight over
the same market share. Mattel currently has a 24% market cap, which is the
Mattel has a 24%
largest of any of the toy manufacturers. This gives Mattel a serious competitive
market cap—the
advantage over its rivals. By being the biggest company, Mattel is able to set
largest of any toy
manufacturer industry standards and lead the way in new and innovative trends, taking hold of
opportunities that present themselves. Mattel also has the flexibility in
manufacturing to keep up with the threats that appear within the toy industry.
For example, there are few toys that Mattel is not able to make, which means
virtually no smaller company will be able to exclusively produce and sell a hot
product without Mattel producing a comparable toy.

Analyzing Mattel’s accounting policies led us to believe that Mattel is a fairly
conservative company with a few aggressive features. Mattel does not have to
take risks that other companies may, due to its sheer size. By using fairly
conservative accounting and business practices, Mattel is able to turn a profit
without exposing itself to risky accounting or business ventures. Mattel generally
implements transparent accounting disclosures as well, meaning that it willingly
divulges information to the public. Based on our research, Mattel does not leave
information undisclosed in order to obscure the image of the company. We could
not identify any potential problems that would lead us to believe that Mattel is
fabricating or changing figures within the financial statements. By using a few
quantitative ratios for the last five years (ex: Net sales/Cash from sales) we were
able to check for problems within the company’s accounting system. All the
changes in the ratios were easily explained and nothing appeared out of the
ordinary.

By forecasting the financial statements we were able to see what kind of structure
Mattel would have for the next ten years. Overall, the results of our forecasts
were very positive. For example, sales ten years from now are projected to be
almost six billion, which is about a 20% increase in sales from the last reported
year. Mattel seems to be in the position to grow at about 2% per year, which is
very realistic. We feel these estimates are very conservative meaning Mattel has
the potential for even larger gains in the future. Also, by using a common-size
income statement, we see that the capital structure of Mattel is projected to
remain fairly constant in the future. To the conservative investor, this is good
news because it means Mattel should not be making any drastic changes in its
business strategies in the near future.

• We consider Mattel to be a strong hold recommendation for future
investors.

Through our in-depth analysis, we have found the stock to be fairly accurately
priced. However, there was a trend in our analysis that seemed to show the
company as overvalued. This trend, although interesting, is not fully reliable due
to the difficulty in estimating the cost of equity for Mattel. Using a sensitivity
analysis we were able to estimate the cost of equity to be somewhere in the range
from six to ten percent. The free cash flow, dividend discount, and residual
income models seemed to be effective in valuing the company; the abnormal
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Executive Summary
earnings growth model was the least effective. As you can see in the summary
above, the estimated share prices for each of the valuation models are off by only
a small amount from the true observed stock price of $19.27. Notice that all
models except the dividend discount model show that the stock should be valued
at a higher price. It may be that Mattel is undervalued in the market by a small
margin, but the difference could also be resulting from the wrong estimate of the
cost of equity, or the weighted average cost of capital. In the above estimates, the
cost of equity ranges from six to nine percent.

Although there may be some estimating error in the models, we feel Mattel is a
profitable stock that the investor should definitely hold. All valuations lead us to
believe that Mattel’s stock is correctly priced, or even slightly undervalued. This
We consider Mattel
means an investor has the chance to capitalize on any undervalued amount. If the
to be a strong hold
stock is priced correctly, it also has a chance to increase in the next ten years due
recommendation
to the growth opportunities and the competitive advantages that Mattel possesses.
For this reason, our recommendation for potential investors is that Mattel is not
only a hold, but a strong hold.
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Business & Industry Analysis
Business & Industry Analysis

M
attel is one of the leading toy manufacturers and sellers in the world.
Producing hundreds of thousands of toys each year, Mattel has managed
to earn five billion dollars in revenue last year (2003) and 4.9 billion the
previous year (2002). The purpose of this report is to analyze the company in
Mattel has earned
$5 billion dollars in relation to the rest of the toy industry. In the first few pages, the industry as a
revenue in 2003 whole will be analyzed in a five forces model, which assesses threats, competition,
and bargaining power. Then, a SWOT analysis will be given to show the
company’s Strengths, Weaknesses, Opportunities, and Threats. Finally, a list of
competitive advantages will be given to explain what the company really excels at
in the industry.

Below is a financial overview of Mattel that shows stock price information as well
as a general summary of the company’s financial statements.

Industry Analysis

Market Cap of Toy Industry
24%
Mattel
Hasbro
Jakks Pacific
11%
63%
All Others
2%

*Mattel has a grip on 24% of the market cap—the largest of any other
toy manufacturer.1

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Business & Industry Analysis
Table 1
Toy Industry
Rivalry Among Existing Firms High
Threat of New Entrants Relatively Low
Threat of Substitutes Relatively High
Bargaining Power of Buyers Low
Bargaining Power of Suppliers Low

Five Forces Model

Competitive Force 1: Rivalry among existing firms

In general, rivalry is very high due to the number of competing companies and
struggle for market share. Because industry growth has already leveled off,
Mattel’s two primary
companies must fight for a set market to survive. In addition, the market for toys
rivals include Hasbro
is fairly concentrated because of competing companies in the industry, including
and Jakks Pacific
Hasbro and Jakks Pacific. This forces Mattel to compete on price and strive to be
the lowest cost competitor.

The switching cost of the consumer is very low in this industry. For example, if a
consumer purchases a similar item from the same store, it will not cost the buyer
any more money to choose a different product. Because of this, toy companies
must engage in price competition, which keeps the level of differentiation fairly
low. Mattel has attempted to create unique products by increasing the popularity
of its goods. For instance, Mattel contracted to make Harry Potter toys to
promote the upcoming Harry Potter film. This is an example of a differentiated
product because children will want “Harry Potter,” and not a Harry Potter
imitation.

The toy industry has a steep learning curve in that the industry requires a lot of
capital and knowledge for new entrants. Toy companies have built strong
relationships and reputations with toy buyers and endorsers. Since Mattel is one
of the largest toy manufacturers, the steep learning curve gives them a significant
competitive advantage.

Because there are no exit barrier regulations within the toy industry, it is not costly
to leave the market. The primary substantial investments a company could
possibly lose are its fixed assets such as machinery and factories, or any contracts
with suppliers that may have been created.

Competitive Force 2: Threat of new entrants

Within the toy industry, there are large economies of scale, specifically in the
marketing segment. In order to inform buyers about upcoming products,
companies must invest large quantities of capital in advertising and marketing.
Designing and manufacturing toys might be fairly easy for smaller companies to
do, but the actual marketing of the products is what is difficult. For example,
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Business & Industry Analysis
Mattel has many well known brands in the marketplace such as Fisher-Price, Hot
Wheels, and Barbie. If it wasn’t for all of the marketing and advertising that went
into each product, these toys wouldn’t be nearly as successful as they are today.
Because of the popularity of these products, it is extremely difficult for new
companies to compete in this industry. This advantage decreases the threat that
new entrants would have over Mattel. It is possible for new companies to enter
the industry, but they will suffer from a cost disadvantage and low beginning
profits.

New entrants may have problems setting up distribution channels because large,
established companies already dominate them. Because larger companies have set
up relationships with suppliers and buyers, they will tend to have more influence
over the smaller companies. For instance, Mattel has set up numerous
relationships with many of its suppliers and buyers that could potentially limit the
number of new entrants into the industry.

One last barrier that new entrants must surpass is the legal barrier. In the toy
industry, this would be patented products. Many potential products, especially
ones related to the movie industry, have patents that only certain companies have
the rights to. For example, Mattel holds the exclusive right to produce the Barbie
doll. Another example is Lego. Mattel has patented its design and holds the only
right to manufacture and distribute Legos. This means that new entrants must
design new products, or secure the rights to existing products to get into the
industry.

Competitive Force 3: Threat of Substitute Products

In the toy industry, depending on the nature of a certain product, there may or
may not be a threat of substitute products. In most cases, the threat of substitute
products is relatively high. A good example of this would be a toy that can be
easily replicated, such as a plastic toy soldier. Most consumers will likely purchase
whatever product is the cheapest. On the other hand, the threat of substitute
products could be relatively low as in the case of technologically advanced or
licensed toys. The key to a successful product is to create a toy that is so
appealing to children that it cannot be substituted. A perfect example would be
the Harry Potter collection which has virtually no threat of substitutes. By
securing this right, consumers are willing to pay a higher price.

Competitive Force 4: Bargaining Power of Buyers

When it comes to the bargaining power of buyers, their overall effect on Mattel is
considerably low. Two factors that determine the power of buyers include price
sensitivity and relative bargaining power. Because most of the products that
Mattel sells tend to be differentiated, buyers are generally less sensitive to
increases and decreases in price. Barbie, for example, is a product licensed by
Mattel that young children love to play with. From a child’s perspective, there is
no other product on the market that can replace the authenticity of a Barbie doll,
thus lowering the price sensitivity of its buyers. Relative bargaining power is
another aspect that determines the power of buyers. Unless there was a huge
volume of products that were being bought, most buyers wouldn’t have much
bargaining power over Mattel toys. Mattel is such a large company with many
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Business & Industry Analysis
differentiated products that most consumers have a relatively low sense of power
over them.

Competitive Force 5: Bargaining Power of Suppliers

Since there are numerous suppliers in the toy industry, companies have a low
bargaining power relative to Mattel. Mattel has the ability to choose the supplier
with the lowest price. Plastic and rubber are good examples of common
resources used to produce toys. They are relatively simple to produce and easily
attainable, which forces the suppliers of these materials to compete heavily among
themselves. This gives Mattel the opportunity to produce low cost products.

SWOT Analysis

Strengths

One of Mattel’s greatest strengths is its ability to gain and maintain strong
relationships with other successful companies. Since the 1950’s Mattel has
maintained a long lasting relationship with The Walt Disney Company.2 As a
strong competitor in the toy industry, Mattel has been able to attract licensing
agreements with major children’s companies.

Brand names (i.e. Fisher Price) are also a large attribute to Mattel. Brands such as
Hot Wheels, Barbie, Fisher Price, and American Girls are well respected and are
trusted by families all over the world. Barbie is currently the #1 girls brand
worldwide with more than $3.6 billion in retail.2 The Hot Wheels brand of toy
cars has been able to attract many young boys and avid collectors of all ages.

Mattel increased its dividends by 13% at the end of the 3rd quarter in 2004.1 This
increase in dividends shows the company has been profitable and is planning to
continue its growth. It is capable of increasing its shareholder value through the
recent profits.

Weaknesses

Thousands of dollars were lost due to recalls associated with the design of the
Batman Batmobile and the potential harm it could have caused to children.4B
This presents a problem with the costs associated with the lawsuits, liabilities, and
consumer appeal.

Mattel took the biggest hit out of its competitors giving up 2% of stock when
Toys “R” Us decided to close its toy retailing market.5 Toys “R” Us lost $46
million in 2003 which contributed to US toy sales decreasing 8.3% to $1.1 billion
reported in the last quarter of 2004.1A

Opportunities

Hasbro, Inc. is recalling nearly 230,000 Super Soaker Monster Rockets in
September, 2004.1B This recall by Hasbro helps Mattel maintain a competitive
advantage over its main rivals. This also shows consumers that Mattel is not the
only company that has had malfunctions with their toys.
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Business & Industry Analysis
Reviving Barbie in September 2004 could increase its sales forecast. Mattel is
currently trying to alter the perception of Barbie by changing her looks and
clothing. Barbie’s image will be changed in order to appeal to young children and
parents today. An example of this future change will be the creation of the
American Idol doll, which will hopefully increase sales in January, once the dolls are
scheduled to be released.1C

Threats

During the Christmas season of 2003, there was a price war in the toy industry
due to Wal-Mart’s low prices. Because Wal-Mart has the capability of lowering its
prices so dramatically, they are able to beat their competitors, such as Toys “R”
Us. Once these stores are unable to compete with the low prices, they cancel
shipments and advertising from the manufacturers, which hurts Mattel. Mattel
and other competitors are trying to avoid the Christmas price wars this year by
giving less hot buy items to Wal-Mart and more to companies like Toys “R” Us.6

314,000 Batmobiles In 2004, 314,000 Batmobiles were recalled by Mattel which caused the injury of
were recalled in fourteen children, making consumers weary of toys.7 Every year millions of
2004 due to sharp
dollars are lost due to toy related lawsuits. Although every toy company
rear tail wings
experiences this, Mattel tries to avoid these lawsuits at all costs.

Another threat to toy manufacturers is the ever-changing popularity of toys.
Because toy fads change unpredictably, many toys are left sitting on store shelves.

Competitive Strategy Analysis

The toy industry is very competitive, and in most situations there are significant
threats of substitute products. Although Mattel does well at being a low cost
competitor, its main strategy for creating a competitive advantage lies in the
differentiation of its products. Mattel is known for its high quality and cutting
edge toys. It invests considerable amounts of money to create innovative designs.
This, in part, is why Mattel has been able to dominate the toy industry for so long.

Another competitive advantage that Mattel has is its reputation. Industries that
are looking to manufacture and sell a certain product to endorse their own
company, such as Walt Disney, will look for the large established companies that
they know can fill the order and create a quality toy. This means that Mattel not
only produces and sells its own toy designs, but those of other companies as well.
This asset along with its successful brand names allows Mattel to keep a
competitive advantage over its competitors.

One more competitive advantage Mattel possesses is the advantage of capital.
Since Mattel deals with high amounts of revenue and cash, it has plenty of extra
capital to spend on marketing, research and development, and quality assurance of
new toys. By having extra capital, Mattel is able to test products to make sure it
meets a high standard of quality.
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