After a dismal week at Mattel Inc. (MAT - Get Report) , which has investors contemplating its value in a sale, a frequent activist investor is now the toy company's second-biggest shareholder.

Southeastern Asset Management Inc. on Tuesday, Oct. 31, reported a 10.25% stake in Mattel, which is topped only by PRIMECAP Management Co.'s 10.73% stake. Southeastern reported a passive stake in a 13G filing, but passive stakes are sometimes converted into activist 13D stakes.

Memphis-based Southeastern's recent investments include United Technologies Corp. (UTX - Get Report) , set to buy airplane parts maker Rockwell Collins Inc. (COL) for $30 billion including debt after pressure from fellow activist Dan Loeb, and Deltic Timber Corp. (DEL) , which Southeastern pressured to pursue a full range of strategic alternatives.

Mattel reported dismal third-quarter financial results on Thursday, Oct. 26. Earnings of 9 cents per share were a fraction of the expected 58 cents per share, sales missed consensus estimates by 15%, and margins fell 700 basis points. The bankruptcy of Toys R Us, which accounted for about 11% of Mattel's sales, helped drag down North American sales 22%.

"We believe the company likely took the opportunity to accelerate asset write-downs including inventory, licenses, and tooling as part of the SKU reduction program, and to also speed up investments in new processes and organizational changes," wrote BMO Capital Markets Corp. analyst Gerrick Johnson, explaining the miss. "Not quite a kitchen sink quarter, but perhaps close."

The company's turnaround plans include lifting its targeted operating cost cuts to $650 million over the next three years, up from the $450 million to $500 million cut forecast in June, with about $215 million in the first year and $430 million cut in the second year. $170 million of the cost savings will be reinvested from 2018-2020 in e-commerce, IT, emerging markets and content and gaming. Mattel also suspended its dividend, saving about $50 million a quarter.

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"We are taking a conservative approach to the sales recovery and post-investment cost savings; from our observation of MAT and the industry, revival cycles take longer, cost cuts are always narrower, and reinvestment is always larger than initially expected," wrote Jefferies LLC analyst Stephanie Wissink.

Barbie dolls.
Barbie dolls.

The next day, S&P downgraded Mattel's debt to BB from BBB-. Thanks to the junk rating, Mattel will likely need a covenant adjustment or waiver, as Wissink estimates its leverage is above five times Ebitda, above the 4.5 limit for Q4 from Mattel's September covenant waiver.

"Lack of access to the commercial paper market and Mattel's limited debt capacity leaves Mattel with limited options to fund operations," Wissink wrote, adding that the company may be forced to exercise a shelf offering or sell off assets.

Fitch followed suit on Tuesday, downgrading Mattel to BBB- from BBB.

Mattel CFO Joe Euteneuer, a former Sprint Corp. (S - Get Report) CFO who joined the company on Sept. 25, also hinted on the earnings call that he's considering "supplemental capital," Wissink wrote. Euteneuer is "highly skilled in structuring alternative sources of financing," she added.

In the meantime, Wissink is "actively studying inherent value as a framework for downside risk." She estimates that Mattel's intellectual property is worth $8 to $10 per share, with tangible assets like real estate adding another $1.50 to $2 per share. Debt would decrease the valuation by about $2 per share, providing a "natural floor" of $8 to $10 per share, or $2.75 billion to $3.44 billion.

Johnson similarly wrote that investors may now value Mattel by its breakup value. He estimates that its brands and manufacturing footprint could fetch more than $10 billion, providing "value to a financial, industry, or entertainment conglomerate buyer," although its debt pile of almost $3 billion may limit the number of financial acquirers.

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Mattel's five "power brands" of Barbie, Fisher-Price, Thomas & Friends, Hot Wheels and American Girl could be worth $8 billion alone, Johnson estimates. Those brands, combined with Mattel's manufacturing facilities and its "underutilized" brands like He-Man, Barney, Bob the Builder and Polly Pocket, are worth about $10 billion.

El Segundo, Calif.-based Mattel in 1996 offered to acquire rival Hasbro Inc. (HAS - Get Report) for $5.2 billion, but Hasbro, citing antitrust hurdles, rejected the offer. Johnson suggested that the antitrust fears may be mitigated now given the "ascendancy" of competing toy brands like family-owned Lego A/S, Canada-listed Spin Master Corp. and MGA Entertainment Inc., the privately held maker of Bratz dolls.

Editors' pick: Originally published Nov. 3.