VideoThere 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.
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