Beyond The Valley Of The Dolls
By Peter Keating

(MONEY Magazine) – You turn 40, and all of a sudden analysts are poking around to see if your inventory is bloated or your profits are sagging. Yes, life has been tough over the past few months for Barbie, who made her debut in 1959, and for parent Mattel, which derives one-third of its $4.8 billion in revenues from the world's favorite plastic babe (Pamela Anderson notwithstanding). Slammed in 1998 by inventory reductions by its biggest customer, Toys R Us, Mattel saw its fourth-quarter earnings plunge 69%, sending its stock price down sharply, to $22.

The bad news has overshadowed the cornerstone of Mattel's strategy for adapting to a world where kids play Nintendo before they enter grade school: its $3.8 billion stock deal for the Learning Company, the second largest maker of consumer software (including "edutainment" titles such as Reader Rabbit and Carmen Sandiego). The purchase should extend Mattel's lead as the top children's products company in the world. "Mattel has put a bad quarter behind it and is now integrating electronic media into its business structure," says Harold Vogel of S.G. Cowen.

While sales of traditional toys such as Barbie dolls are increasing only 2% to 4% a year, Mattel is moving on three fronts to achieve long-term annual earnings growth of 15%. First, adding the Learning Company will boost its sales of high-margin software from $100 million a year to $1 billion. Second, Mattel is broadening its distribution channels with catalogue, direct-to-consumer and Internet sales. And, third, it sees more potential in Europe, where parents annually spend about $200 per child on toys, compared with $350 in the U.S.

Hasbro, Mattel's main rival, is poised for a big year as it rolls out a slew of new Star Wars toys. But over the long haul, Mattel and Hasbro are both likely to gain at the expense of smaller fry in the consolidating toy market. Analysts expect Mattel's earnings to rebound 26% this year, which could push the stock back into the low $30s.

--PETER KEATING