WHAT’S IN STORE FOR 2018?

by SEAN MCGOWAN, managing director, Liolios Group

It’s January as I write this, and in honor of two-faced Janus, let’s look back on the state of the toy industry in 2017 and, more importantly, see what 2018 might have in store. As I think about 2017, the word that most frequently comes to mind is “Wow.” Just, “Wow.” Regardless of which side of the political aisle you favor, the year began and ended with a bunch of “WOW!s,” with a couple of “WHOA!s” thrown in here and there, and more than a few “WTF!?s” along the way.

In fact, 2017 was full of so many surprises, it’s hardly worth repeating the predictions I made in this column last year, since in hindsight, whether or not they turned out to be true was of little relative consequence.

BUT, LET’S QUICKLY REVIEW LAST YEAR’S PREDICTIONS:

• China will be a source of concern. Yeah, not so much.
• Much more moderate industry growth. Yep, that turned out to be true.
• Currency will matter. Yes, the dollar strengthened, but that was hardly a top five event.
• LEGO likely to be No. 1. Yep, the brick kings of Denmark quietly took the top spot.
• Amazon will continue to gobble market share. Duh.

So, all in all, not too bad on last year’s predictions, but what’s more noteworthy are the things that happened that I did not predict. And that starts, of course, with the bankruptcy filing of Toys “R” Us. Was it a surprise? Well, if you have an uncle that everyone in the family knows is sick, but he doesn’t take care of himself and suddenly has a heart attack, is it a surprise? Well, maybe you’re surprised the day it happens, but when you look back, it probably wasn’t such a shock. Now, (to continue the analogy to the point of beating it into a state of equus mortis), the good news is that the uncle can quit smoking, give up the fried food, and start visiting the gym more often, and there’s a pretty good chance he’ll live a longer life.

Another unpredicted (at least by me) surprise last year was the passage of the tax cut. It’s not that I didn’t think that Republican control of all branches of government didn’t make a tax cut very likely, I just didn’t imagine that they’d get it done so quickly.

I was also surprised to see the rumors of a Hasbro and Mattel merger surface again, this time with seemingly greater credibility. Much has changed since the two giants first discussed a merger more than 15 years ago. First, this time around, Hasbro played the role of the potential buyer. Second, the toy industry saw significant shifts in the retail landscape, both in competition from other entertainment segments, and in industry leadership at the top (see LEGO, above). One reason I was so surprised by this news was that it seemed clear that Hasbro’s CEO was more interested in making acquisitions that would transform the company into a more rounded, vertically integrated entertainment company, not simply a much bigger version of a traditional toy company. Perhaps over time, combining the two companies could accomplish that, but first Mattel would need to be fixed.

I feel like I would be remiss not to mention one of the industry’s biggest surprises in 2017—a product whose appearance and popularity surprised most of us, and whose rapid fall seemed almost just as surprising. Fidget spinners seemingly came out of nowhere last spring, and, by the end of the year, were drowning in their own ubiquity. I wish there was a cogent lesson to come out of that whole thing, but all I got is, “Come up with a hit, and if you can’t protect the trademark, sell as much of it as you can as fast as you can.”

Let’s focus for a moment on one of the predictions that was right—that industry growth would be much more modest in 2017 than in the prior few years. Specifically, let’s consider a few reasons that could explain why that turned out to be the case. First, comparisons have become a bit more difficult. Going into 2017, the industry enjoyed better growth over the prior five or six years than it has experienced in the decade or so before that. Relatively strong economic growth across the world (another positive surprise, I’ll admit) might have been expected to lead to another strong year, but showing growth on top of several years of growth is difficult, particularly if the growth was driven by some hit products that were bound to slow down.

Second, certain formerly reliable film properties became less reliable. I wrote about this last year when I predicted more moderate growth, and we did, in fact, see some properties either fail to catch on or sustain some early popularity. Wonder Woman, for example, did quite well at the box office, but didn’t generate much in the way of toy sales. Sales of Star Wars merchandise were generally below the levels of prior releases. The LEGO Ninjago Movie didn’t lead to LEGO’s toys regaining the retail heat they had a few years ago. Other films that didn’t provide the retail lift one might expect include Cars 3, Power Rangers, Smurfs: The Lost Village, and Justice League. Perhaps the only properties that lived up to or exceeded expectations were Beauty and the Beast and Moana (released in late 2016).

The slowdown in growth may be the result of the shift to online sales. Online retail sales are so big that they are taking a substantial bite out of brick-and-mortar retail sales, instead of providing some incremental growth for the industry.

Another theory is that Nintendo’s resurgence is causing the slowdown. Consumers who would not otherwise buy and play traditional toys are fueling the continued growth of video games for PlayStation and Xbox, since these games are aimed at older audiences. This is not as true for Nintendo’s Switch console, which is the most family-friendly gaming console on the market.

A lot of the factors that affected sales in 2017 will continue to impact the industry into 2018. Here are four additional predictions for what’s to come:

IF TOYS “R” US EMERGES FROM CHAPTER 11, IT WILL BE HEALTHIER, BUT…

Assuming Toys “R” Us emerges from bankruptcy with a reworked capital structure and access to working capital financing, the company should be able to have a decent year in 2018. And from where we stand right now, there is no reason this can’t happen. But, we do have to recognize that a high debt load alone is not what led to the retailer’s troubles. The company needs to scale back its store footprint and make investments in its operations to improve its competitive position—but its competitors are not simply standing by. And getting back on solid financial footing is a big “if.” The confidence of its vendors will have to improve from current levels in order for the company to get the trade credit it needs.

HASBRO WILL NOT ACQUIRE MATTEL

Whatever logic there is to combining the two companies still holds, but I don’t think it will actually happen for a couple of reasons. First, the current enterprise value is more than $8 billion, meaning any kind of premium will drive this close to $10 billion. While I won’t argue that Mattel isn’t “worth” this much or more, this amount doesn’t quite make it a “steal.” In addition, Mattel’s board and management have a lot of new faces—they are probably less inclined to accept a quick “flip,” and more likely to want to engineer a longer-term, more rewarding turnaround.

USER-GENERATED CONTENT MAY BECOME USER-GENERATED TOYS.

When a new technology comes along, everyone gets excited enough to claim it as the “next big thing.” This was true of virtual reality (first hyped more than 20 years ago and still on the cusp), 3-D TVs in 2010, and curved TVs in 2015. So, some skepticism might be warranted regarding whether or not low-priced 3-D printers might become popular among toy consumers. Prices for printers keep coming down and the devices are getting simpler even as the quality increases. It feels like this segment is poised for a breakout, and this could be a pivotal year.

HASBRO AND LEGO WILL FIGHT FOR THE NO. 1 SPOT

LEGO has been bumping up against Mattel for the title of world’s largest toy company. By some measures, they reached that milestone years ago, but changes in the exchange rate between Danish krone and dollars kept the champagne on ice. It seems clear now that when final results are reported, LEGO will be No. 1, followed by Hasbro at No. 2, and Mattel at No. 3 (yes, rough spot for Mattel, falling two slots). But it came during a year when LEGO announced that first half sales had fallen for the first time in many years and that it was reducing its head count, also for the first time in years. Staying at the top may prove challenging. Both Hasbro and Mattel face some challenges this year, but the combination of currency moves and weakness of some licenses could leave Hasbro an opening to claim the title in 2018. It’s likely to be a close fight.

BONUS PREDICTION

The 2018 midterm elections will be one of the most consequential in many years, and their outcome will be so closely watched that we may see more of an impact on consumer sentiment than is typical for a midterm. Just when you thought it was safe to ignore politics…

Have a terrific Toy Fair.

 

Sean McGowan is a managing director on the consumer team of the Liolios Group, which provides capital market navigation and advisory services. He has been closely following the toy industry for 30 years, analyzing product trends, cost changes, marketing practices, and other aspects of how products and companies succeed (or don’t). He also follows digital gaming, sporting goods, and juvenile products. In addition, he is on the board of advisors of the Toy Industry Foundation.

 


This article was originally published in the February 2018 issue of The Toy Book.