Mattel Has Nobody to Blame but Itself for The Learning Co. Fiasco
From the "never mind that note earlier today that said I wouldn't write until Tuesday" department: Every now and then, a company that has been a long-term target of criticism by short-sellers for accounting gimmickry gets out of a jam by getting itself acquired by another company. Only the company doing the buying is so desperate to get out of its jam that, long after the deal is done, it winds up getting blindsided by problems it never knew existed at the company it bought.
Quaker Oats' (OAT) purchase of Snapple a number of years ago was a classic. So too, it will be proved, was Mattel's (MAT) purchase of The Learning Company. This morning, Mattel warned that it would post "significantly" lower-than-expected third-quarter earnings, thanks to a variety of problems with The Learning Co., especially higher-than-expected product returns, which led to a $50 million bad-debt writeoff.
Surprise, surprise! No stranger to this column, The Learning Co. had been a target of short-seller scrutiny for years before the Mattel purchase. The shorts claimed, among other things, that TLC's accounting was too aggressive, its distribution channel was overstuffed with product and that, based on its income statement and balance sheet, it was headed for trouble.Yet last year, just when red flags were flying high over The Learning Co., it agreed to sell itself to a gullible Mattel. And the purchase came just as Mattel itself was warning that its earnings wouldn't be all they were cracked up to be. At the time, even this column raised questions about the deal. What was written in that column is important to review today because it makes you wonder how much due diligence Mattel really did. To quote from that column:
Sounds to some skeptics like two desperate companies doing one desperate deal. Why else, they wonder, would Mattel, which trades at 2 times sales, swap its stock for a company that trades at 4.5 times projected sales? Why else, they wonder, would Mattel buy a company that has been the target of charges, for years, of stuffing the distribution channel to make its numbers look better than they really are? Along those lines, why else, they wonder, would Mattel buy a company whose receivables, in recent quarters, have been rising faster than sales -- if you included the amount of receivables that had been sold off to investors? Why else, they wonder, would Mattel buy a company that itself has done upwards of $1.3 billion in takeovers, with much of the combined purchase price being written off? (Makes some critics wonder what was in those writeoffs, and adds further doubt to the quality of TLC's earnings.) And why else, they wonder, would Mattel buy a company that has bought numerous other companies, including Broderbund, whose fundamentals have been failing? Why else, they wonder, would Mattel buy a company whose operating earnings are an unusually robust 26%, twice the margins of Electronic Arts (ERTS), which is with little doubt one of the best operators in the game industry? (Such a big discrepancy doesn't sit well with some critics.) Why else, they wonder, would TLC's management sell the company, at this time, if the biz is so good? Maybe the answer is that before getting into the software biz, TLC Chairman and CEO Michael Perik was a currency trader in Canada. Mattel's purchase of TLC, it would appear, is the ultimate trade.And what a deal it was. In August, less than three months after the Mattel-TLC marriage was final, TLC Chairman and CEO Michael Perik and TLC President Kevin O'Leary both filed to sell 250,000 shares of their Mattel stock worth $5.8 million. Both are still employees of Mattel, with annual salaries of $650,000. Perik didn't return my call; O'Leary was said to be traveling today and unavailable for comment. As for Mattel, it says it first learned of trouble with TLC last week. What's more, a spokesman insists the company did its pre-deal due diligence. Maybe so, but apparently it wasn't diligent enough.
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