Toys "R" Us Gets FAO Schwartz

One of the largest toy retailers in the world is getting bigger. Toys "R" Us announced this morning that the company has acquired FAO Schwarz. Terms of the deal were not disclosed.

Both companies are privately held. FAO Schwarz was bought out of bankruptcy by a private equity firm in 2004, and Toys "R" Us was purchased for $6.6 billion in 2005 by an investment group led by private equity firms.

FAO Schwarz operates only two retail stores -- its flagship location in New York City, and a location at Caesar's Palace in Las Vegas. The acquisition also includes the company’s e-commerce and catalog operations, and gives Toys "R" Us control of an iconic brand name in the toy industry.

This move has implications for the two largest toy manufacturers, Mattel (MAT - Analyst Report) and Hasbro (HAS - Analyst Report), as Toys "R" Us is a major customer for both companies.

During 2008, Toys "R" Us accounted for approximately 11.9% of total sales by Mattel, or $700 million, making it the company’s the second-largest customer. For Hasbro, Toys "R" Us accounted for approximately 10% of sales, or roughly $400 million, last year, making it the company’s third-largest customer.

Wal-Mart (WMT - Snapshot Report) remains the largest customer for both Mattel and Hasbro, leading Target (TGT - Snapshot Report) and Toys "R" Us by a substantial margin. This acquisition will certainly not challenge that status. However, Toys "R" Us could improve its positioning relative to its toy retailing peers, if the company is able to leverage the FAO Schwarz brand.

The net result of this deal to Mattel and Hasbro is likely neutral. Although Toys "R" Us may increase its market share via this transaction, the move is not likely to expand the overall market size, at least in the near term.

Retail sales of toys declined last year, as consumers felt the impact of the economic recession and curtailed discretionary spending. Although we expect the two largest toy manufacturers to gain market share in this environment, the outlook remains challenging as long as consumer spending continues to be suppressed.