Mega ended its annus horribilis with its share price in the $6 (Canadian) range and a roughly $100-million loss for 2007-the first in the company's history. To reduce debt, it put the Rose Art division, still responsible for about 40% of its sales thanks to the non-Magnetix lines, on the block. Mega initially reported that there were more than 20 expressions of interest-including one from the ousted Rosen brothers. But a deal never materialized. Observers believe most of the interest came from private equity players, and dried up as the financing market froze.
Entering 2008 facing supply-chain problems, strained relations with retailers, ongoing lawsuits and $252 million of debt from the Rose Art acquisition, Mega pledged to turn things around. Marc Bertrand promised to streamline operations, recover lost margins and return to pretax profitability by 2009. And while the company did claim a profitable third quarter (as long as you don't count the $150-million writedown of goodwill), it's continued to struggle with its distribution network. After the tainted-toy scandals, the industry's Chinese supply chain went through an upheaval last year, with many companies going under and the survivors demanding stricter payment terms. Last summer, there was rampant speculation that Mega wasn't paying its suppliers, which would have led them to stop shipments. "That could have been the end right there," says Caron-"a Christmas holiday season with no Mega Bloks on the shelves."
In August, Mega struck a deal with Prem Watsa's Fairfax Financial Holdings Ltd., which has become a specialist in investing in distressed companies. Fairfax invested $64 million (Canadian), which it can convert into shares that would give it more than a third of the company-and almost three times the stake of the Bertrand family. Caron calls the transaction "a deal of last resort." According to another analyst, the Bertrands are no longer fully calling the shots.
For all its travails, Mega has made progress. It has reduced expenses and inventories, hired an independent quality-control company to monitor production in China (where 75% of its toys continue to be manufactured) and shuttered some distribution facilities. "Operationally, Mega's doing what they need to do, but the timing is tough," says Caron. "[Last year]was a very bad year for everybody."
III: LEGO SURGES BACK
Well, not for everybody. Lego had a record 2008. While the toy industry slumped by 3% amid a swooning economy, Lego's North American division saw sales grow by 37%, extending a run of strong results thanks to such smash hits as the Bionicle action figures and Star Wars toy sets and video games. The company's U.S. market share in the construction category jumped 7% last year alone, to 73%. "It's a simple headline: We've focused back on the core," says Søren Torp Laursen, the North American chief. "We needed to fix our core business with boys aged 5 to 9. Now that's fixed."
A globetrotting Lego lifer, Laursen has spent the past five years fixing operations on this continent, tapping the Hollywood connection whose importance Lego so disastrously underestimated in its dark days. The Star Wars franchise in particular has proven to be a gold mine: Sales of toys and games are growing by double digits even though there hasn't been a new Star Wars movie since 2005. Last year alone, Star Wars-related Lego sales in the U.S. surged by 78%. While there has been a "rebalancing" toward non-licensed lines, Lego's not turning away from Hollywood. In fact, Lego wrested the coveted Disney licence away from Mega early this year, positioning itself to profit from looming Toy Story and Cars sequels.
Lego's return from the brink has followed a well-tested recipe: First, bring fresh blood into the corner office-in the person of Jørgen Vig Knudstorp, a former McKinsey consultant who took the reins from the Christiansen family. Second, shore up the balance sheet by selling off extraneous divisions, notably the amusement parks. Third, refocus on what you do best-delighting boys with ever-new marvels that can be made out of a few plastic bricks. Fourth, become as efficient as your rivals.
In 2006, Lego broke with company tradition by outsourcing manufacturing to lower-cost countries, but it has never ventured into China, believing production lead times would be too long-faster response to market trends being one of the keys to its turnaround. Laursen says Lego may soon be able to go from manufacturing order to product on the shelves in as little as six weeks. "That means that in October, we can read the success of our fall launches before we decide on the Christmas quantities, whereas our competitors that use China have to make those calls before the products are on the market."