CORPORATION: Trying Times for Transformers Toymaker

With the Steven Spielberg-produced Transformers a summer smash in theaters worldwide, these should be happy days for Tomy, the Japanese company that makes the shape-shifting toys on which the blockbuster film is based.

Yet with news headlines dominated by made-in-China scandals involving toymakers such as Mattel (MAT), there's no fun in Toyland. Tomy, like so many other Japanese and Western toy companies, relies on factories in China to manufacture most of its toys, and that Chinese sourcing is now causing big problems.

On the heels of Mattel's Sept. 4 announcement of a recall of Barbie accessories and other toys due to worries about dangerous levels of lead paint, the share price of Tomy, which has product-licensing agreements with Mattel, is languishing at a four-year low. Tomy shares fell 2.6% on Sept. 5 in Tokyo trading, marking their lowest level since August, 2003. The stock price is down more than 22% this year, compared to a 6.2% drop for the Nikkei index.

Quality problems associated with Chinese production are the biggest immediate concern for investors. On Aug. 17, Tomy said it would recall Chinese-made toy cars that it markets and distributes for Mattel in Japan after finding lead in the paint. That move wiped 10% off the stock price, although the company bravely insists it has no regrets. "We want to provide consumers as much proof as possible so as to guarantee the quality of our products," says Seiichiro Wasahara, a spokesman at the company.

Bringing Back Old Fans
While the China scandals dominate the headlines now, Chinese factories aren't the only problem for Tomy. Just as worrying, at least in the longer term, is that the company's main market, Japan, is shrinking as the population ages. Statistics show just how bleak the future is. By 2030, the National Institute of Population & Social Security Research predicts Japan's population of 127.7 million will fall by almost 10% and that youngsters will number fewer than one in 10, from around 13.6% now.

To fill the void, the company is targeting adults for one of its hottest toy rollouts in years. To coincide with the release of Transformers in Japan, Tomy is rereleasing dozens of the morphing robot toys that the company hopes will be a hit with generations X and Y. "The Transformers have had an image in Japan of being only for children," says Masahiko Yamazaki, who leads Tomy's marketing effort. "We'd like to bring back old fans and create a new market for adults."

The need to appeal to a broader audience is clear. In the past, Japan's toymakers had plenty of toy and game tie-ins to TV programs and movies for kids. But with Japan's youth population rapidly declining, they're being forced "to expand the market by increasing the targeted age range," says Fumiaki Ibuki, editor of Toy Journal.

Tough Competition from Astro Boy
The prized demographic in Japan: baby boomers' kids, who are now in their 20s and 30s. These consumers, known as junior boomers, have cash to burn and kids with whom they are eager to share memories of their childhood.

When Takara [later bought by Tomy] first released Transformers in the U.S. in 1984, the giant robots that could morph into cars, planes, and other vehicles were a novelty. A year later, they were introduced in Japan to rave reviews. But the toys' popularity ebbed a few years later, and only the most die-hard fans have remained loyal. What's more, Tomy's Transformers now have to hold their own against a slew of other robot characters -- from Osamu Tezuka's Astro Boy to giant flying robots such as Mazinger Z and Gundam -- that have proven far more enduring.

That's likely to make it a hard slog for Tomy in Japan, where the company has exclusive rights. [Hasbro (HAS) owns the Transformers' marketing license in the U.S. and other key overseas markets.] Though 300 million Transformers toys have been sold in more than 130 countries over the years, Japan has only accounted for 10% of sales.

No Earnings Transformation Expected
But that hasn't deterred Tomy. Ahead of the film's release, the company sold 16 different robot characters from the movie, and this month another two dozen will appear in stores worldwide. There is even a collaboration with Nike (NKE), called Free 7.0, which looks like a sneaker but contains a robot inside, and an Apple (AAPL) iPod version is expected soon. Eventually, 80 different products are slated for release.

Tomy says it hopes to do more than $50 million in Transformers sales this fiscal year, through March, 2008. That might be possible, but sales in Japan so far have been disappointing, according to Mizuho Investors Securities. Says Shoji Morita, an analyst at Okasan Securities: "In the U.S., there are many success stories of a hit movie leading to a hit toy. In Japan, however, hit products are always connected to TV anime or TV programs such as Pokemon and Gundam."

In fact, few expect the Transformers to help Tomy's earnings much. Tomy produces Transformers for U.S. toymaker Hasbro, but the Japanese company's profit margins from the arrangement are miniscule, and Transformers-related sales have amounted to less than 10% of the company's total.

But even if the Transformers flop, some analysts think Tomy will still get by. In the first quarter, Tomy's operating earnings swung to a profit of $500,000 from a $2.6 million loss a year ago, and sales rose nearly 15%, to $342 million. Etsuko Tamura of Mizuho Investors Securities says Tomy's Tomica trains and Barbie-look-alike Licca-chan dolls are big enough sellers to lift the company's profits this year. For the financial year, she projects operating profits will grow 57%, to $40 million. If only Tomy's stock price could show a similar recovery. "It's disappointing as we've had healthy revenue growth," says spokesman Wasahara.

From Yahoo business news.