There was no hiding it anymore: The Learning Company Inc. was a monumental loser. For Mattel Inc., which had paid $3.5 billion for the educational software maker in December 1998, Learning Co. oozed more than $1 million a day in losses by last summer, and had sparked lawsuits from disgruntled shareholders. By the time the giant El Segundo, California-based toy maker put the unit up for sale last April, it knew it faced a hard time convincing a buyer--any buyer--that Mattel's problem could be the buyer's opportunity.
The need to cut loose a dog of an acquisition is increasingly common these days. Even beyond the famous research showing that most deals hurt shareholder value, this is "a time in history when investors are punishing disappointing performance more severely and more rapidly than ever before," says Mark Sirower, head of the mergers and acquisitions practice in New York for The Boston Consulting Group and author of The Synergy Trap. "If you have an asset that looks bad, you can't just sit with it and let it continue to bleed." Examples of desperate divestitures abound, including Quaker Oats Co.'s 1997 sale of Snapple Beverage Corp. at a $1.4 billion loss, the dumping of Telerate by Dow Jones & Co. at less than a third of its $1.6 billion price, and Conseco Inc.'s shutdown of Green Tree Financial Corp., for which it had paid $6 billion two years before.
Mattel CEO Robert Eckert and CFO Kevin Farr had among the tallest of orders, though, given the short and disastrous life span of Mattel's relationship with Learning Co.--a relationship that had been designed to soup up Mattel's Hot Wheels, Barbie, and other brands for a high-tech future, using educational software that had turned Reader Rabbit and the elusive spy Carmen Sandiego into household words. But in the end, Barbie and Carmen just couldn't get along. Only months after closing the purchase, Mattel was being nagged by a problem unfamiliar to the toy business: high levels of returned software. Previously profitable, Learning Co. started reporting losses. By this March, Mattel had decided to dump it, along with the original deal's celebrated architect, thenMattel CEO Jill Barad.
Mattel got no up-front cash in the deal. Indeed, it made time itself a key element, choosing to shed the negative earnings impact of Learning Co. immediately and to begin a restructuring that is designed to cut $200 million in costs over the next three years. And in one interesting twist that may prove instructive to others with a similar divestiture quandary, the seller chose not to pull away entirely from the operation it was selling: Mattel retained rights for a profit participation in Learning Co. under the new owner.
"It is a side bet--something of an out-of-the-money option that they're receiving," says Sirower. Such bets are rare among larger divestitures, he says, except for the indirect gamble represented by a seller taking a buyer's stock as part of the price. It would be wise for sellers to thoroughly examine the value of the option if it is offered in place of up-front payment. "But if your base case is that you can't sell a property," adds Sirower, "then it can't hurt you to have options."
Gores Versus Gores
For a good divestiture, the seller must try to do some of the potential buyer's valuation homework for it, says Sirower. Eckert and Farr, who blamed the software industry's softness and ongoing computer-chip shortages for Learning Co.'s woes, knew that the universe of interested parties was limited. Among other toy companies, for example, No. 2 Hasbro Inc. had recently begun seeking "strategic alternatives" for its own interactive unit, which had lost about $170 million in the previous two years. And most of the seven or eight technology and media concerns that initially inquired about the property wanted only part of it, according to sources close to the negotiations.
At first, Mattel allowed some cherry-picking, selling the Cyberpatrol Internet-filtering software division of Learning Co. to the United Kingdom's JSB Software Technologies Plc (now SurfControl Plc) in July for about $100 million, all but $2.5 million of it in stock. (At one point after the deal, Mattel's $97.5 million share holding in SurfControl dropped by a third because of a fall in the stock price.) Mattel talked with Havas Interactive Inc., Europe's top-selling educational and reference publisher, about a $185 million offer for the rest of Learning Co., but that potential deal ultimately fizzled on antitrust concerns.
Eventually, the bidding for the bulk of Learning Co. came down to two strikingly similar technology buyout firms--companies operated, in fact, by brothers based in Los Angeles. Neither Gores Technology Group, run by Alec Gores, nor Platinum Equity Holdings, headed by Tom Gores, offered cash up front. But Mattel remained a choosy beggar, wrangling fiercely over future profit-sharing arrangements that were at the heart of the pricing. It also held tight to certain proprietary brand software that it brought into the initial Learning Co. arrangement, even though that intellectual property might have won it up to $1 billion had it been factored into the deal, according to some analysts' estimates.
When Platinum bowed out, citing the pricing, Gores Technology's offer remained, and the decision was Mattel's. "Mattel checked us out pretty heavily," says Alec Gores, who adds that the seller made "lots of phone calls and [took] a very close look at our past cases." Mattel declined to comment for this article on its approach to the deal, or to disclose profit-sharing terms. In sketchy official comments on the sale, Mattel says only that it will retain "a contractual right to receive future consideration" if Learning Co. turns profitable or is sold again. Mattel wrote down about $430 million after taxes from discontinued operations in connection with the sale. It is restructuring $250 million in Learning Co. debt, offsetting the first year of cost savings Mattel expects to experience from shedding the software operations.
Gores Technology's record apparently passed muster, and encouraged Mattel that there might indeed be a chance of a return from Learning Co. under new ownership. Since beginning operation in 1992, Gores Technology has quietly taken more than 30 noncore technology units from large companies, including the Quortech Solutions Inc. network system management unit of Nortel Networks and Computer Sciences Corp.'s Artemis Management Systems Inc. software division. It has turned about half the companies it has taken over profitable, according to Alec Gores. Learning Co., with about $500 million in current annual revenues, is its biggest bleeder to date, but otherwise fits into the buyout firm's general acquisition profile.
"Believe it or not, 70 percent of the mistakes are the same in every situation we go into," says Gores. Mattel was no different. "I believe Mattel's strategy was right at the time," he continues, "but unfortunately, they overpaid and didn't really do their homework and didn't understand the software business. Then they got caught up in finger-pointing and forgot about the business." Gores Technology has set aside $100 million to help restructure Learning Co., potentially by splitting it into three separate units. It confidently predicts profitability within six months, which, of course, could pump earnings back into Mattel.
While analysts generally were disappointed that Mattel failed to get any up-front cash for the property--some had expected as much as $500 million--a few say Mattel executives were wise to get rid of Learning Co. quickly. "The hard decision was the right move," says Jill Krutick of Salomon Smith Barney in New York. "They could have waited for a better offer, but that would have increased shareholders' losses and [the better offer] may never have materialized." Adds Standard & Poor's equity analyst Tom Graves, "Selling it in pieces might have generated a bit more up-front cash, but this deal gives them more upside potential."
And while Gores Technology wasn't well known to analysts, David E. Weisberg, president of Technology Automation Services, an Englewood, Colorado, consulting firm, calls Gores Technology a shrewd buyer and an able reorganizer. "They do not bite on everything that's put on their plate," he says.
How Now, Dow Jones?
Only time will tell whether Mattel's divestiture strategy pays off. But if the sale evolves into anything more than a giveaway, it may not be such a bad deal compared with other companies' albatross-abandonment efforts. Quaker Oats's sale of Snapple for $300 million in 1997 left Quaker with a $1.4 billion write-down. It had paid $1.7 billion for Snapple, then learned that bottled iced teas didn't fit as neatly as it had hoped with Quaker's hugely successful Gatorade product line. Snapple also soured because of backlash from rivals The Coca-Cola Inc. and PepsiCo Inc., which reacted to Gatorade's success by launching iced-tea brands that competed against Snapple. Unfortunately for Quaker, which itself was recently targeted by PepsiCo, there wasn't a plan for Snapple profit participation, as there is in the Mattel/Learning Co. deal. Snapple's buyer, Triarc Cos., a small beverage and restaurant company, used its nimble management structure to turn the acquisition around. Just this summer, Triarc sold the property to Cadbury Schweppes Plc for approximately $1.45 billion, including debt assumption of $420 million.
Not that residual gains from a sale always come through. When Dow Jones & Co., the Wall Street Journal's parent, sold off its suffering Telerate electronic financial information system to Bridge Information Systems Inc., it hoped that Bridge's efforts to turn Telerate around would translate into a rise in Bridge's shares. After laying out $1.6 billion for Telerate, then struggling with it for a decade, Dow Jones unloaded the operation to Bridge in 1998 for $510 million, including $150 million of Bridge preferred stock. The Bridge stock has hardly been a winner, cutting the value of Dow Jones's holding to $80.3 million in the latest third quarter. At that time, thenDow Jones CFO Jerry Bailey told analysts, Dow Jones was taking a one-time charge of $82.3 million. (Bailey also said in September that he was leaving the company for family reasons.)
For what it's worth, Mattel's sale of Learning Co. could end up comparing favorably with the experience of Conseco, the life and health insurer that struggled long and hard to get rid of subprime mobile-home lender Green Tree Financial (renamed Conseco Finance). Although Conseco officially put Green Tree up for sale in April, hoping to recover some of its $7.5 billion announced purchase price, new CEO Gary Wendt later took it off the auction block, partially shutting it down at a cost of $156.2 million in the third quarter. "There's a good reason for that," says Boston Consulting Group's Sirower. Conseco "couldn't find a good buyer." Green Tree, he says, was a major catalyst in Conseco's $15 billionplus loss in market capital since the April 1998 announcement.
"A lot of these disasters are not surprises. The market generally hammers them from day one of the announcement," adds Sirower. "Good deals," he notes, "don't start out that way."
Alix Nyberg is a staff writer at CFO.
Some companies that were forced to shed units they acquired, after disastrous operating experiences with them.
Source: The companies; press reports
|Parent Co.||Original Acquiree||Price/year||Disposition Terms|
|Mattel||The Learning Company|| $3.5 bill.|
|Sold for future earn-outs to Gores Technology, with no up-front payment. (10/00).|
|Conseco||Green Tree Financial||$7.5 bill.|
|Renamed Conseco Finance, partially shut down (10/00).|
|First Union||The Money Store||$2.1 bill.|
|Shut whole unit down with $2.8 billion write-off charge (6/00).|
|Dow Jones||Telerate||$1.6 bill.|
|Sold for $510 mill. in stock and cash to Bridge Information Systems (3/98).|
|Eli Lilly||PCS Health Systems||$4.1 bill.|
|Sold for $1.5 bill. to Rite-Aid (1/98). Resold for $875 mill. to Advanced Paradigm (10/00).|
|Quaker Oats||Snapple Beverage Group||$1.7 bill.|
|Sold for $300 mill. to Triarc (3/97). Resold to Cadbury Schweppes for $1.45 bill. (10/00).|