A Toy-Stock Story for Value Investors KIDS, CLOWNS, AND GREAT RETURNS AT NOODLE KIDOODLE
By Jeremy Kahn

(FORTUNE Magazine) – These are tough times in toy land. Furby fever aside, toy retailers are whining that there aren't enough hot products on the market anymore. Kids are outgrowing simple mass-market toys like plastic action figures and dolls at ever younger ages and demanding more sophisticated entertainment (sports equipment, computer games) --then quickly outgrowing those, too, and ceasing to buy toys altogether. The trend is reflected in toy-store earnings. Same-store sales at Toys "R" Us--by far the largest U.S. toy retailer, with 704 domestic outlets--fell 7% in 1998 from the previous year during the all-important holiday shopping season. At Kay-Bee Toys, a subsidiary of Consolidated Stores, sales crept up just 2% during roughly the same period.

But there is one toy stock poised to provide investors with fun-filled returns in the year ahead: Noodle Kidoodle (ticker: NKID), a 42-store chain specializing in educational toys and software. Its same-store Christmas-season sales were up 12%, beating analysts' single-digit growth estimates. In fact, Noodle had a great 1998, as its stock surged 153% from 3 3/4 to 9 1/2--even touching 11 5/8 at one point. Analysts expect the company to post earnings of $2 million, or 25 cents a share, for the year.

The good news doesn't stop there. Twelve more outlets are scheduled to open this year, and Sean McGowen, a toy analyst at Gerard Klauer Mattison, recently upped his 1999 price target for the retailer from $12 to $14. (In early February it traded at 7 5/8) It's the only toy company he currently has a "buy" recommendation on.

What's Noodle's secret? For one thing, the company, based in Syosset, N.Y., operates in the only segment of the toy market enjoying robust growth. The educational software, videos, books, science kits, and puzzles it sells appeal both to kids looking for entertainment beyond G.I. Joe and Barbie and to anxious yuppie parents desperate to give Junior an intellectual boost in a hypercompetitive society.

Moreover, Noodle's stores--located predominantly in affluent suburbs in the Northeast, South, and Midwest--aim to turn shopping into parent-child "quality time." At 8,000 square feet, they are larger than typical specialty shops but more intimate than a cavernous Kmart or Toys "R" Us. Well-lit, carpeted, and brightly decorated, they feature shelves children can reach, plenty of well-trained salespeople, free gift-wrapping, and a "try it before you buy it" policy that allows kids to play with toys, run computer software, and screen videos before deciding on a purchase. Now add in frequent product demonstrations, story times, and clowns and musicians. "We want the trip to Noodle Kidoodle to be fun in and of itself," says CEO Stanley Greenman.

Sure, competitors like Zany Brainy, Imaginarium, Store of Knowledge, and Learningsmith follow similar concepts, but none of them are publicly traded. Nor do the majors show any sign of radically altering their product mix to imitate Noodle, says Harry Ikenson, an analyst with Hambrecht & Quist. (More than half the products Noodle sells aren't even available at mass-market stores.) Why not? Stores like Toys "R" Us, designed to compete in a high-volume, low-cost, low-service arena, can't afford the shelf space and staff needed to sell more sophisticated products.

With 1998 revenues of just under $100 million, Noodle Kidoodle is a mere dollhouse next to Toys "R" Us' $11 billion mansion. But it may be the best game in town for investors.

--Jeremy Kahn