Mattel Inc (MAT.O), the world's No. 1 toymaker, offered to buy Canada's Mega Brands Inc MB.TO for about $460 million to better compete with Denmark's Lego, the leader in the fast-growing market for building blocks.
For the past three years, the demand for construction toys, especially Lego's colorful building blocks, has been growing at the expense of action figures and preschool toys - the forte of Mattel and its main rival Hasbro Inc (HAS.O).
That pushed Lego's sales up 10 percent in a sluggish global toy market in 2013, helping it overtake Hasbro to become the No. 2 toy company by sales globally. Mattel's sales rose 1 percent and Hasbro's were flat in 2013.
Mega Brands, founded in 1967, sells building blocks that directly compete with Lego, and will help Mattel garner a larger share of a market that Chief Executive Bryan Stockton said had some of the highest margins in the toy industry.
"Mattel currently has less than a 1 percent share in the category. This is the single largest toy category where Mattel does not play," Mattel's Stockton said on a call with analysts.
Mega Brands, which sells construction blocks under the MEGA Bloks brand, estimated it has a 10 percent market share globally.
Shares of Mattel, known for its Barbie and Hot Wheels brands, were slightly higher at $37.13 on the Nasdaq.
The company offered C$17.75 per share of Mega Brands, representing a premium of 36 percent to the stock's close on Thursday.
Mega Brands' stock hit a high of C$17.89 in early trading on the Toronto Stock Exchange, indicating some investors were expecting a higher offer.
However, analysts said there was minimal chance of a rival offer for Montreal-based Mega Brands, which has long been viewed by some as a viable acquisition target for Mattel.
"While the possibility of another offer exists, particularly in a toy industry dominated by giants, we feel it is unlikely," National Bank Financial analysts led by Leon Aghazarian wrote in a note to clients.
Mattel's stock has fallen about 9 percent in the past 12 months. The stock trades at 13.86 times forward earnings, while Mega Brands' shares trade at 9.44 times.
BATMAN VS BARBIE
Mega Brands also sells construction sets under licensed brands such as HALO, Hello Kitty, SpongeBob SquarePants and Mattel's Barbie and Hot Wheels. Lego offers toy sets based on Star Wars, the Simpsons and DC comic characters such as Batman.
The deal will also help Mattel expand its arts and crafts offerings with the addition of Mega Brands' Rose Art collection.
Sales of building sets as well as arts and craft toys increased in the United States in 2013, amidst a 1 percent fall in overall toy sales, according to market research firm NPD Group. The fall was driven by declines in sales of action figures and preschool toys.
Both Mattel and Hasbro posted lower-than-expected results in the holiday selling season, when toymakers typically make about 40 percent of their annual revenue.
Mega Brands estimated net sales of $405 million in 2013. Mattel said it expects the deal to hurt earnings in 2014, before adding to profit next year.
Mattel said shareholders holding 39 percent of Mega Brands, comprising Fairfax Financial Holdings Ltd and the company's founding family, have agreed to vote in favor of the deal.
Fairfax, run by Prem Watsa, is Mega Brands' largest shareholder with a stake of 27.4 percent as of December 31.
Mega Brands will pay Mattel a termination fee of $12 million if it accepts an unsolicited proposal, subject to Mattel's right to match the proposal, the companies said in a joint statement.
Mattel said it plans to fund the acquisition through a combination of new debt and cash. The deal is expected to close in the second quarter.
RBC Capital Markets is acting as financial adviser to Mattel, while Latham & Watkins LLP is acting as legal adviser and McCarthy Tetrault LLP as Canadian legal adviser.
Rothschild is acting as financial adviser and Osler, Hoskin & Harcourt LLP is acting as legal adviser to MEGA Brands.
(Additional reporting by Sneha Banerjee and Ashutosh Pandey in Bangalore; Editing by Savio D'Souza)