Lionel's Next Stop: The Public Markets?
Famed toy train maker exits bankruptcy on firmer footing
By Aleksandrs Rozens May 19, 2008
On the final day of hearings for Lionel LLC's bankruptcy in May the judge overseeing the case remarked that the famed model train maker thrived during its bankruptcy, making its restructuring an unusual one. In fact, the business actually saw an improvement in its fortunes during its nearly three-and-a-half years under court supervision.
Lionel's revenues rose from $48 million in 2004 to about $70 million last year thanks, in part to the firm's push into larger retailers such as Macy's and Target as well as a general campaign by the company to bring back its name to the broader public's consciousness by a chief executive with experience as a publisher at a magazine owned by Playboy and at comic book giant Marvel.
Now that it is out of bankruptcy, Lionel's CEO has big plans for a toy train company that was started up by an Eastern European immigrant not far from the Lower Manhattan court house where it emerged from court protection.
Gerard Calabrese, the New Jersey native who runs Lionel these days and shepherded it through its bankruptcy, wants to get the company's products into department stores and build a presence in malls where it could be an American Girl Place for boys -- and their fathers. Calabrese aims to bring the love of toy trains to a broader audience with lower-priced products while at the same time catering to hobbyists who shell out $2,000 for museum-quality locomotives that weigh more than 50 pounds. And, if the timing is right -- and if the revamped Lionel is ready for it -- Calabrese says Lionel could someday be listed as a public company.
"Two or three years from now, with $150 million in sales and the hobby business the same size as it is now, then yes," it could be taken public, says Calabrese. But, before that happens the Lionel brand has to become a household name with the introduction of a wider range of low-cost products, film and television projects and a push into retail chains. Getting all that done will be tough, as Lionel's chief executive concedes, because of a slowing economy and rising prices of commodities that make Lionel toys costlier to produce. Higher energy prices make shipments of 40-yard containers laden with Lionel's toys from overseas factories more expensive too.
"Is going public a good idea? Yes, depending on whether we can pull off the things we have planned for the next two years," says Calabrese.
How Lionel Was Derailed By Bankruptcy
When Joshua Lionel Cowen built his first train on Manhattan's Lower West Side near City Hall, the powered toy ran in a circle and was designed as a novelty to attract passersby to the store window's display. As Lionel grew, the toy company's trains were made in large plants in New Jersey and, later, Michigan. The company changed hands several times over its 100-year-plus history and for a short period was owned by General Mills which planned to but never actually made the Lionel toys in Mexico. Lionel's bright orange boxes have a Chesterfield, Mich., address -- the site of a former company production plant -- but these days many toy trains are made in South Korea which is prized for its expertise in die-casting.
Competition between two of these overseas manufacturers over the lucrative outsourcing of toys from companies like Lionel and one of its competitors, Mike's Train House, or MTH, sparked the series of problems that landed Lionel in bankruptcy.
Based in Columbia, Md., MTH was started up in 1980 by Mike Wolf, who had been a fan of toy trains since he was 12. Wolf's company was founded in the home he grew up in and, like Lionel, specializes in the production of model trains in a size commonly known as O gauge.
Korea Brass, a South Korean company that made diecast toys for Lionel, was accused of stealing design drawings and scheduling information from MTH's Korean supplier Samhongsa. Korea Brass was also accused of then using the information to design and build trains for Lionel.
"It was never alleged that we stole those or had anything to do with it. Nor was it ever alleged we had knowledge of [Korea Brass] doing that," Calabrese recalled in an interview with IDD last week. "The early conflict was in South Korea and it was between factories." Lionel's CEO sipped coffee from a paper cup, sitting in the model train company's midtown showroom with several layouts showcasing the company's products as he recalled the problems overseas that set the stage for its bankruptcy. A construction crew hammered away in the background, the expansion of a space to be used as a showroom for buyers representing retailers.
South Korean courts found Korea Brass was guilty of misuse of the other factory's information and the manufacturer was fined by that nation's courts. Lionel's CEO believes the fine totaled under $20,000.
After that ruling made in an overseas court, MTH sued Lionel and Korea Brass in the US District Court for the Eastern District of Michigan in 2000. MTH accused Lionel of violating the state's trade secrets laws and in its suit MTH alleged Lionel knew or should have known that MTH trade secrets were being incorporated into Lionel products. Four years later, a jury returned a verdict in favor of MTH for just over $40 million. In November 2004 the Michigan District Court entered judgment in favor of MTH. Soon after, Lionel filed for bankruptcy protection in New York's Southern District Bankruptcy Court.
"This suit was the culmination of a long battle between MTH and Lionel. MTH was the new company [led and run] by really talented, really driven train makers who make great products," says Calabrese. "Lionel was a company that for many years had rested on its laurels. MTH was making products that made people want to buy MTH trains."
The Sixth Circuit Court of Appeals later would overturn the judgment, but those three-and-a-half years in bankruptcy allowed Calabrese to put some of his ideas into action. "There was no way we could continue" without the bankruptcy, says Calabrese.
Looking back at the case in Michigan that resulted in the award going to MTH, Calabrese wonders if the jury really understood the nuances of the business of making toy trains. "This is really complicated stuff," says Calabrese, adding that some members of the jury may have missed subtleties about toy manufacturing when it came to its decision. "I am not saying there was not some smoke, but I don't think it was worth $40 million," says Calabrese who declined to say what the final settlement was between MTH and Lionel.
Calabrese recalls that Lionel's case may have been hurt, too, by the fact that the famed toy company had shuttered a Chesterfield, Mich., factory some 30 miles outside of Detroit that happened to employ UAW workers not long before MTH's suit.
Captain Marvel
Calabrese joined Lionel as its chief executive in September 2004. While it may, at first, appear that he came on board the Lionel train wreck as a restructuring professional, his arrival at Lionel was actually tied to plans to buy the firm before the company petitioned for bankruptcy protection. Calabrese's plans were scuttled when MTH filed its suit and was awarded the $40 million -- a figure that scared off Calabrese's private equity backers. (He declined to name the PE firm.)
Working at Marvel, Playboy and NASCAR, Calabrese had seen how some businesses generate massive income through licensing and in the months before Lionel's bankruptcy he had conducted extensive due diligence of the toy train maker. At Playboy and Marvel income was earned through licensing in overseas markets. Marvel also generated income from television shows, something not lost on Calabrese because Lionel sells toy trains related to The Polar Express, a film based on a popular children's book aired frequently on television between Thanksgiving and Christmas. Why not apply business ideas learned at Marvel to Lionel, he wondered. "I said 'this isn't a train company. This is an intellectual property. My background is in intellectual property.'"
The fight for control of Lionel during its bankruptcy was brutal. MTH, the largest creditor by virtue of the award from its suit, tried to keep Lionel from being the debtor in possession. MTH questioned Calabrese's ability to run the business. After all, they reasoned, what does a comic book guy know about toy trains? Amid its hectic bankruptcy Lionel found that its chief engineer was selling its technology to a competitor called K Line.
Calabrese managed to retain control of the business and his first moves included reaching out to hobby shops that sold Lionel products -- everything from reproductions of electric locomotives that raced between New York and Washington, DC for the Pennsylvania Railroad to large Union Pacific steam engines that weigh in excess of 50 pounds -- and convince the retailers that he was not about to wind down the business, something often associated by the public with bankruptcy. The outreach also involved the Internet where there were online chats with Lionel's customer base.
"I assured them I wasn't going to liquidate the company. I was a brand development guy," says Calabrese. "The loyalty to the brand from dealers and fans was such that they wanted to believe."
The skirmishes with MTH would continue during bankruptcy and involved arguments over patents for complex controls akin to TV remotes that allow train buffs to simulate all the noises and sounds of real trains with microchip technology. MTH had its own system and accused Lionel of using its technology. Some of Lionel's systems had been developed by the rock 'n roll artist Neil Young, a model train fan, who had patents for special remote controls. (Young had a stake in Lionel prior to its bankruptcy and he still has a stake in the company.) In addition to fights over patents regarding remote control technology two railroad companies, Union Pacific and CSX, got into the mix with protests over the use of their logos. These issues were eventually sorted out by Calabrese, who had to go visit each railroad's corporate offices and negotiate an agreement allowing Lionel to use the rail company logos on its toys.
At the same time, Calabrese wanted to increase the company's sales to an audience beyond the hobbyist willing and able to buy $2,000 locomotives. Lionel needed to generate higher revenues and to do so it would need to sell more of its beginner train sets priced at $129 to $300 to a wider range of consumers. When Calabrese joined Lionel in 2004 the company had $48 million in annual revenues and it sold under 100,000 train sets. Three years later, Lionel sold 200,000 train sets and its revenues totaled about $70 million.
Looking back at the company in 2004, "we rested on our laurels more than we should have," says Calabrese. "We really dug in to improve our product, improve our distribution and improve our sales and just go to work rebuilding the core hobby base."
Typically a bankruptcy makes it tough for companies to sell their products to retailers such as Macy's or Target, but that is exactly what Lionel managed to do while it was under court supervision. Lionel, with the help of a Texas-based set designer, built elaborate operating train layouts featuring mountain and city scenes that were exhibited in Macy's stores during the Christmas shopping season. "Common wisdom is you will never crack major retailers in bankruptcy. The power of this brand was so strong that telling the story of what we were going to try to do was meaningful enough that we actually began to crack large retail accounts," says Calabrese.
But how does one convince a retailer to do business with a debtor under court protection? "I told them we didn't run out of money. We got nailed with a lawsuit, but in the meantime we have all these new products, we have all this momentum and enough people believed," says Calabrese.
At the same time, Lionel's logo and name was used for Christmas tree ornaments in a longstanding deal with Hallmark, glasses with the Lionel logo will be sold by retailer Linens 'n Things this Christmas season, and Macy's offered plush toys -- a bear wearing railroad overalls. It was, as Calabrese puts it, "pop culture traction."
To ensure the brand does not get burned out Calabrese is dealing directly with the retailers and products are tailored for each retailer. For example, Target in 2006 sold a Lionel set with the theme "The Big Box of Trains You Wish Your Mother Had Not Given To Your Brother."
Lionel was starting to reach out for a broader customer base, while at the same time keeping its core fans happy with a steady production line of new highly-detailed products.
Next Stop?
Getting the Lionel name out to a broader group of consumers likely will have the company get involved with multimedia entertainment such as programming for television or DVDs. "Lionel could have been [involved with] a film like The Polar Express," says Calabrese. "We are talking to major studios and other partners in doing this," meaning the multi-media projects.
The power of television is not lost on the former Marvel executive. After all television programs helped keep alive interest in Marvel comics and toys before the recent flurry of Hollywood films, he says.
"If you establish the retail connection to sell the products and you have a head start on actually developing what products can be used and you have a brand like ours we think that is a pretty good combination," says Calabrese. "It is too early to guess where we would start with this. We are actively now looking at what we'll do to create media to drive our product line."
(c) 2008 Investment Dealers' Digest and SourceMedia, Inc. All Rights Reserved.
