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Tonka Corporation
Tonka Corporation, the fifth-largest toy company in the United States, had two of the most successful years in its history in 1985 and 1986. The company’s sales of $293 million and profitability of $22 million were unprecedented; Tonka had also issued more than one million shares of common stock in December 1986 and had retired its long-term debt in January 1987, both of which contributed to its low leverage and high liquidity.
Becoming and remaining financially sound was a difficult task in the toy industry because of the typically short life spans and “hit-or-miss” nature of most products. Now, in February 1987, Tonka’s management was undergoing a capital-structure policy review in an effort to determine whether the company could use its financial resources more efficiently and yet remain conservative.
The Toy Industry
Over the past several years, a trend toward consolidation was evident within the toy industry. In 1983 the top five toy companies in the United States were responsible for 32.7 percent of total sales; by 1986 that figure had risen to an estimated 44.2 percent. In 1984, Hasbro, Inc., acquired Milton Bradley, best known for the board game Monopoly, and in 1985, it acquired certain assets of another toy company, Child Guidance. In 1986 alone, Coleco Industries had acquired two other companies (including Selchow & Righter, the producer of Scrabble and the blockbuster board game of 1984, Trivial Pursuit), the product line of another company, and the North American subsidiary of Tomy Kogyo, a toy company that specialized in hightechnology applications. See Exhibit 1 for the results of these consolidations.
Of the approximately 800 toy companies in the United States, only the largest were able to minimize sales and profit volatility through diversification. Even they were not always successful, however, as shown in Exhibits 2 and 3. Each company’s fortunes rose and fell with the success or failure of its latest products, and even the biggest “hits” tended to have life cycles of only one or two years. In 1984 Coleco’s sales, for example, rose from $597 million to $775 million, then declined to $501 million in 1986. Kenner Parker’s sales rose from $539 million in 1983 to $648 million in 1984, before falling back to $503 million in 1986. Mattel’s sales rose rapidly for two years then stabilized for two years at about $1.06 billion. Tonka’s sales, however, grew rapidly for four straight years.
Exhibit 4 provides a breakdown of total industry sales by product type. With the exception of games and puzzles, plush toys, and infant and preschool toys, estimated 1986 sales by category were flat or down by as much as 25 percent, as was the case with action figures, dolls, and electronic games. As a result, overall industry sales were down $27 million in 1986. Within each segment, the basic and technologyenhanced toys did well, and industry analysts expected retailers to limit inventory risk in 1987 by concentrating on those types.
Regarding the strength of the toy industry as it moved into 1987, a December 1986 report stated:
Aggregate industry shipments remain flat. . . . The industry has essentially been unable to offset this softening with any meaningful new or exciting category of products.[1]
The toy industry was also susceptible to changes in demographics, in seasons, and in the economy. By early 1987, the factors that contributed to toycompany sales were sending mixed messages. According to an August 1986 industry report,
Demographic trends are increasing demand for toy products. A rising number of births is creating more toy recipients for the next ten years. Also, an increasing percentage of births (over 40 percent) is now firstborn children, and more dollars (estimates as high as 45 percent more) are generally spent on firstborn. Finally, an expanding population of grandparents due to divorce and the increasing number of twoincome families are resulting in more buyers with more money to spend on toys.[2]
As shown in Exhibit 5, the U.S. economy had just experienced its fourth straight year of economic growth. Growth of real gross national product was down, but so were unemployment and interest rates, and real per capita disposable income rose 2 percent in 1986.
The Company
Tonka Corporation was best known for its traditional line of sturdy metal toy trucks, bulldozers, backhoes, and construction vehicles, which were responsible for about $70 million of corporate sales in recent years. Over the past several years, however, the company had diversified into other products, including dolls and other toys that would be more appealing to girls. One of Tonka’s greatest successes over the past two years had been GoBots—small vehicles that could be changed into action figures; they competed directly with Hasbro’s Transformers, which generally outsold them. GoBots contributed $132 million to sales in 1985, but in 1986—even though 41 new characters were introduced, including large Super GoBots, and even though 33 episodes were added to the Saturday morning cartoon series Challenge of the Gobots—only $25 million worth were sold, a signal of the end of the product’s life cycle. The company closed out the GoBots product line later in the year.
Even more successful for Tonka had been its line of Pound Puppies, which contributed $34 million to corporate sales in 1985 and $156 million (53 percent of sales) in 1986. Pound Puppies were plush toys with broad age appeal across genders. In addition, Tonka introduced Puppy Newborns, Super Pound Puppies, and Pound Purries in 1986, as well as accessories such as a doghouse, dog dish, and clothing.
As a result of its recent successes, built on its relatively nonvolatile sales of toy trucks, Tonka’s revenues rose from $81 million in 1982 to $293 million in 1986. (Exhibit 6 gives the last three years’ income statements.) Between 1982 and 1986, earnings per share rose from $0.12 to $3.04, despite the stock offering of 1.1 million shares in December 1986. Between 1984 and 1986, return on assets rose from 6.9 to 14.1 percent, and return on average equity increased from 16.7 to 28.8 percent. See Exhibit 6 for information on Tonka’s consolidated income statements. Exhibit 7 provides information on Tonka’s stock price during this growth period.
Tonka’s consolidated balance sheets for 1985 and 1986 (Exhibit 8) indicated a rising current ratio (from 1.66 to 2.52). This liquidity stemmed not only from the company’s strong sales, but also from the December 1986 stock offering, which netted $22 million, or $20.27 per share. Exhibit 9 details the company’s debt structure, which totaled $8.1 million and $8.2 million for the past two years.
Company Prospects
Stephen Shank, Tonka’s president and chief executive officer, stated the greatest challenge facing the company:
First, Tonka’s performance is still too dependent on the success of a single line of products—be it GoBots in 1985 or Pound Puppies in 1986. The challenge is to expand our base of stable toys.[3]
Tonka reviewed between 3,000 and 4,000 new toy ideas each year. For 1987, the company’s hopes were pinned on Pound Puppies, its traditional line of trucks, and the nine other toy lines described in the Appendix. (See Exhibit 10 for current and projected Tonka sales by product line.) The company’s objective was to increase the number of product lines to the point where no single toy would account for more than 25 percent of sales. One industry analyst stated, however,
After reviewing the company’s 1987 line, we can find nothing particularly distinctive or exciting of a breakthrough nature that would dramatically enhance the company’s industry presence or market share.[4]
As another challenge, Shank also said, “. . . we have the need and the opportunity to build our sales base internationally, where Tonka’s market share is much smaller than in the U.S.”[5]
The estimated $5-billion developedcountry toy market was witnessing increased penetration by U.S. companies, except in Japan. In most markets, nonU.S. companies tended to be smaller and, therefore, had fewer strong brands and weaker marketing programs than those of U.S. companies. Exhibit 11 provides information on Tonka’s domestic and international operations. The decline in international revenues and the resulting $100,000 operating loss (which led to a $1-million net loss) were primarily caused by a sharp decline in GoBot sales in Canada. Total sales in the United Kingdom and Australia improved in 1986. Management stated Tonka’s objective for its international business in 1987 was
. . . to achieve significant sales growth and a return to profitability. For the longer term, our goal is to build international sales to 30 percent of consolidated revenues compared with 11 percent in 1986. Our strategy is to continue to strengthen Tonka’s position in its existing international markets, primarily Canada, the United Kingdom, and Australia, and to enter other major markets.[6]
In 1986, Tonka began to introduce other products in addition to its traditional line of trucks internationally, and it planned to make most of its toys available in its larger international markets in 1987. The company had also just agreed to become the exclusive distributor in Australia and New Zealand for Bandai Company, Ltd., Japan’s leading toy company.
Conclusion
Tonka’s management wanted to determine what the possible financial results of different degrees of leverage might be. Exhibit 12 provides pro forma financial summaries for Tonka in 1986 under alternative capital structures. The exhibit assumes debttototal capital ratios of 20 percent, 40 percent, and 60 percent, which reflects the range of leverage for the major toy companies in 1986, as shown in Exhibit 2. It also assumes that the recapitalizations would have been achieved through stock repurchases. Revenues, cost of debt, and payout ratios are assumed to be the same as Tonka’s actual 1986 results.
As part of its review, Tonka’s management also studied the interest-rate data provided in Exhibit 13. Management was trying to determine whether the company could use its financial resources more efficiently than at present; but in light of the cyclical and seasonal nature of the business and the company’s dependence on strong toy introductions, it wanted Tonka to remain conservative.
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Exhibit 1
TONKA CORPORATION
Percentage of Industry Sales by Company
(dollars in %)
Est.
1982 1983 1984 1985 1986
Coleco Industries 7.8% 9.4% 10.2% 9.2% 6.0%
Hasbro, Inc. 2.1 3.5 9.4 14.7 16.1
Kenner Parker Toys1 N.A. 8.5 8.5 7.6 6.0
Mattel, Inc.2 21.1 9.9 11.6 12.5 12.6
Tonka Corporation 1.2 1.4 1.8 2.9 3.5
Subtotal for 5 largest
toy companies 32.2% 32.7% 41.6% 46.9% 44.2%
______
1Kenner Parker was a wholly owned subsidiary of General Mills until November 1985.
2In 1982, Mattel sales included revenues from Ringling Brothers, Barnum & Bailey circus.
Sources: Steven Eisenberg, Toy Industry Review (Bear, Stearns & Co., December 1986), 1; Value Line Investment Survey.
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Exhibit 2
TONKA CORPORATION
Comparative Financial Data, 1986
(dollars in millions, except per-share data and stock prices)
Kenner
Coleco Hasbro Parker1 Mattel Tonka
Sales $500.7 $1,344.7 $502.8 $1,058.7 $293.4
Net income (111.3) 99.2 16.0 (1.0) 22.3
Current assets 393.5 601.5 329.1 587.5 134.6
Current liabilities 287.7 272.4 109.0 252.5 53.5
Longterm debt 307.9 125.0 99.6 297.5 8.2
Net worth (7.7) 580.3 199.7 152.4 96.3
Return on sales NMF 7.4% 3.2% NMF 7.6%
Return on equity NMF 17.1 8.0 NMF 23.2
Earnings per share ($6.52) $1.71 $1.22 ($0.20) $3.04
Dividends per share 0.00 0.09 0.00 0.00 0.07
Average P/E NMF 14.0 16.8 NMF 8.1
Beta 1.30 1.15 N.A.2 1.20 1.10
Stock price range:
High $20.5 $30.9 $24.0 $15.5 $32.3
Low 8.3 16.6 15.1 7.8 15.9
Book value (0.5) 10.4 17.1 2.5 12.6
______
NMF: Not a meaningful figure.
1Current assets and current liabilities as of 3/29/87.
2Insufficient data were available to calculate a beta, because Kenner Parker had been a wholly owned subsidiary of General Mills until November 1985.
Source: Value Line Investment Survey, 1986.
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Exhibit 3
TONKA CORPORATION
Toy Industry—Company Sales
(dollars in millions)
1982 1983 1984 1985 1986
Coleco $510.4 $596.5 $774.9 $776.0 $500.7
Hasbro 137.9 225.4 719.0 1,233.4 1,344.7
Kenner Parker N.A. 539.3 648.1 638.3 502.8
Mattel 1,341.9 633.4 880.9 1,050.9 1,058.7
Tonka 81.1 87.8 139.0 244.4 293.4
Source: Value Line Investment Survey.
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Exhibit 4
TONKA CORPORATION
Toy Industry—Sales by Category
(dollars in millions)
Est.
1982 1983 1984 1985 1986
Action figures/dolls $882 $1,036 $2,316 $3,000 $2,300
Electronic games 2,605 2,397 1,094 800 600
Games/puzzles 617 514 1,043 1,100 1,300
Cars, boats, planes, trains 752 707 789 800 850
Infant/preschool 459 508 715 900 1,000
Plush animals 281 300 544 800 1,300
Sports/outdoor 348 328 419 400 423
Arts/crafts/models 353 326 391 350 300
Riding toys 232 255 285 250 300
Total $6,529 $6,371 $7,596 $8,400 $8,373
Source: Steven Eisenberg, Toy Industry Review (Bear, Stearns & Co., December 1986), 1.
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Exhibit 5
TONKA CORPORATION
Summary U.S. Economic Data
1980–86
Per Capita
Annualized
Disposable Change in Average Net
Real Personal Consumer Prime Merchandise
GNP Income Unemployment Price Lending Exports
Growth (1982 $) Rate1 Index Rate1 ($ in MM)
1980 -0.2% $9,722 7.1% 13.5% 15.27% ($25,480)
1981 1.9 9,769 7.6 10.4 18.87 (27,978)
1982 -2.5 9,725 9.7 6.1 14.86 (36,444)
1983 3.6 9,930 9.6 3.2 10.79 (67,080)
1984 6.8 10,419 7.5 4.3 12.04 (112,522)
1985 3.0 10,622 7.2 3.6 9.93 (122,148)
1986 2.9 10,947 7.0 1.9 8.33 (144,339)
1986—Q1 5.4 10,842 7.1 (0.4) 9.00 (34,978)
Q2 0.6 11,024 7.1 0.3 8.50 (33,651)
Q3 1.4 10,968 7.0 0.5 7.50 (37,115)
Q4 1.5 10,956 6.7 0.6 7.50 (38,595)
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1Quarterly figures are end of period.
Source: Economic Report of the President.
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Exhibit 6
TONKA CORPORATION
Consolidated Income Statements
(dollars in millions, except per-share data)
Fiscal year
1984 1985 1986
Net revenues $139.0 $244.4 $293.4
Cost of goods sold 93.9 131.9 159.3
Gross profit 45.1 112.5 134.1
Advertising expense 13.8 40.2 45.7
Selling, general, & administrative 19.4 29.9 43.1
Other expenses (income) -1.9 2.6 1.2
Interest expense, net 5.5 3.6 3.8
Earnings before income taxes 8.3 36.2 40.3