Mattel Overpays for The Learning Company Despite disturbing discoveries during due diligence, Mattel

Mattel Overpays for The Learning Company

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 Despite disturbing discoveries during due diligence, Mattel
acquired The Learning Company (TLC), a leading developer of software for toys,
in a stock-for-stock transaction valued at $3.5 billion on May 13, 1999. Mattel
had determined that TLC’s receivables were overstated because product returns
from distributors were not deducted from receivables and its allowance for bad
debt was inadequate. A $50 million licensing deal also had been prematurely put
on the balance sheet. Finally, TLC’s brands were becoming outdated. TLC had
substantially exaggerated the amount of money put into research and development
for new software products. Nevertheless, driven by the appeal of rapidly
becoming a big player in the children’s software market, Mattel closed on the
transaction aware that TLC’s cash flows were overstated. For all of 1999, TLC
represented a pretax loss of $206 million. After restructuring charges,
Mattel’s consolidated 1999 net loss was $82.4 million on sales of $5.5 billion.
TLC’s top executives left Mattel and sold their Mattel shares in August, just
before the third quarter’s financial performance was released. Mattel’s stock
fell by more than 35% during 1999 to end the year at about $14 per share. On
February 3, 2000, Mattel announced that its chief executive officer, Jill
Barrad, was leaving the company.

On September 30, 2000, Mattel virtually gave away The
Learning Company to rid itself of what had become a seemingly intractable
problem. This ended what had become a disastrous foray into software publishing
that had cost the firm literally hundreds of millions of dollars. Mattel, which
had paid $3.5 billion for the firm in 1999, sold the unit to an affiliate of
Gores Technology Group for rights to a share of future profits. Essentially,
the deal consisted of no cash up front and only a share of potential future
revenues. In lieu of cash, Gores agreed to give Mattel 50% of any profits and
part of any future sale of TLC. In a matter of weeks, Gores was able to do what
Mattel could not do in a year. Gores restructured TLC’s seven units into three,
set strong controls on spending, sifted through 467 software titles to focus on
the key brands, and repaired relationships with distributors. Gores also has
sold the entertainment division.

Case Study Discussion Questions

1. Why did Mattel disregard the warning signs uncovered
during due diligence? Identify which motives for acquisitions discussed in this
chapter may have been at work.

2. Was this related or unrelated diversification for Mattel?
How might this have influenced the outcome?

3. Why could Gores Technology do in a matter of weeks what
the behemoth toy company, Mattel, could not do?

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