Writing Finis to Mattel’s Harsh Learning Co. Experience: Gores Technology Hopes to Turn Around The Troubled Software Firm It Got for Nothing

Imagine doing an LBO without leverage. Or being able to bypass leverage because nothing was paid to acquire the company. Is it a dealmaker’s dream? Or did the buyer pick up such a nightmare that it “paid” just what the business was worth? Those are just two of the questions hanging over the unique deal in which Mattel Inc. turned the cash-bleeding Learning Co. over to Los Angeles-based buyout firm Gores Technology Group in return for only an undisclosed slice of future royalties. That’s the same Learning Co. for which Mattel forked over $3.5 billion in 1999 in what is being ranked as one of the worst acquisitions of all time. Although he concedes that the big entertainment and educational software producer was “a mess” at the time of the takeover, Gores Technology chairman Alec Gores says that he will have answers sooner rather than later and they will show that his firm made a good deal for both sides. In fact, Gores says that there is a chance that his team can put Learning Co. in the black within six months of the deal’s completion in mid-October. Outside analysts of the market are less confident, maintaining that Learning Co.’s problems go deeper than toy maker Mattel’s lack of experience in running a software business. Their view is that Mattel paid a bundle for an operation whose CD-ROM-based technology was virtually passe. While he declined in a telephone interview to describe what he considered the exact nature of Learning Co.’s woes, Gores says that his people “pinpointed some specific problems” during due diligence and then dispatched a “SWAT team” to gather more details. “Now we can verify that and put a final plan together,” he asserts. “It’s a matter of executing the plan.” Despite the admitted challenge, Gores says that the ingredients for a turnaround are in place, including an almost unparalleled stable of popular software brands, such as “Reader Rabbit,” “Carmen San Diego,” “Print Shop,” “Myst,” “Chessmaster,” and “Pokemon.” “The company does need some major restructuring,” he says. “But it has some very, very valuable assets. It has some very good people and a lot of superb managers. It has the foundations to get this company back on track and get it back into a good position.” However, Peter Kreisky, entertainment and media analyst at Mercer Management Consulting, likens Learning Co.’s CD-ROM technology to the “buggy whip” of software because access is rapidly shifting to the Internet. “Mattel invested in yesterday’s technology rather than upgrading to tomorrow’s” he says. “It then failed to make the investment required to make the transition. Learning Co. is CD-ROM-based and the company had to convert the consumer franchise into Internet franchises.” Kreisky warns that the shift is expensive and risky – two issues that Mattel may not have wanted to tackle. He points out that several Learning Co. competitors have been moving to the Internet but none have made any money from it. The Learning Co. that Mattel acquired in fact was the product of a faltering strategy that couldn’t keep up with a breakneck pace of change. Atop its original core, the company acquired competitors such as Broderbund and Sierra, which also were grounded in CD-ROM offerings. “At the time of the Learning Co. roll-up, nobody expected that it would be essentially the last buggy whip manufacturer,” Kreisky states. “CD-ROM-based software was undermined by the Internet at a speed that nobody anticipated.” Aggravating the technology problem was that Learning Co. sells into an entirely different distribution channel than Mattel. While toys, dolls, and games are hawked mostly through toy retailers, such as Toys R Us, or mass merchandisers, such as Wal-Mart, education and entertainment software goes through bookstores, such as Barnes & Noble and Borders, or computer outlets, such as CompUSA. “With software, there is a 100% return privilege,” Kreisky says. “It was not something that Mattel was used to.” A major reason for Gores’ confidence is that his firm, one of the few private equity firms specializing in technology buyouts, has played the turnaround game before – although nothing on the scale of Learning Co., which posted sales of $750 million in its latest fiscal year. “We have done 35 transactions in the last 10 to 12 years,” he says. “Fifty percent of them were turnarounds, and we were successful in every one.” Gores says that his people move fast, such as in the case of Artemis Management Systems, developer of enterprise-class project management software, which was on its uppers when acquired from Computer Sciences Corp. On sales of between $60 million and $70 million a year, it was losing $10 million to $12 million, giving up market share and seeing people leave. “We went in and it was profitable in less than a year,” he says “We stabilized revenues very quickly, stabilized the customer base, and in the second year, we started to grow the company.” Earlier this year, Artemis worked out a “reverse merger” with publicly traded Proha of Finland, and Gores claims that it is “worth 1,000% more than when we bought it.” Gores also is pleased with System Software Associates Inc., a troubled software producer that the buyout firm bought out of public ownership last April for $52 million in cash and a 25% equity stake in the reorganized company. “It was losing a lot of money – $50 million to $60 million a year on $300 million to $400 million in revenues,” Gores states. “In the first quarter after the deal was completed, we got it to a break-even point, and it should be profitable by the third or fourth quarter.” Kreisky says that the new owner might find a “nice profitable niche” for Learning Co. by selling through retailers such as Barnes & Noble and Borders. But that doesn’t offer any growth, which is going to be dependent on the Internet, where the risks and costs are daunting. “It’s a question of growth,” he says. “How do you get growth and how are you going to grow this in such a way that it is profitable?” The best course, Kreisky says, might be to leverage the brand names by letting other firms handle the merchandising. “They can license the franchises to somebody else,” he says. “The Internet is incredibly risky.”