*SmarterKids.com, Earlychildhood Merge in Toy Retail Consolidation

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The market's growing impatience with stand-alone Internet retailers has forced educational toy store SmarterKids.com Inc. to combine forces with Earlychildhood.com LLC, a cataloger and manufacturer of learning products for the preschool, elementary and child-care center market.


The merger particularly will help SmarterKids, Needham, MA, trim marketing costs, add another direct channel and possibly gain more revenue through sales of Earlychildhood's proprietary, higher-margin educational products. The deal is expected to close by spring.


This development also is indicative of the difficulties faced by Internet-only toy retailers in a market dominated by traditional multichannel brands or online first-movers.


"SmarterKids, by itself, was obviously in a fight for its life in the midst of the 800-pound gorillas of Toys "R" Us/Amazon, eToys, Wal-Mart, Target, bluelight.com -- they're all selling toys successfully online," said Tom Wyman, online retail analyst at J.P. Morgan Securities, San Francisco.


"Without the brand equity and buying scale, SmarterKids ... wasn't going to be very long in this," Wyman said. "It does have a high-quality Web site [but] it's hard for the company to get recognition because most consumers don't even know it exists."


Online since 1998, SmarterKids has more than 254,000 customers that buy educational toys, books, games and software. It has more than 160,000 children's learning profiles registered on the site.


"It's very good at database marketing," Wyman said. "It collects over 200 pieces of data through customer transactions that it micro-markets back to [customers] in ways that materially impact their results."


Besides staving off a potential cash crisis, SmarterKids' deal with Earlychildhood, Monterey, CA, will bolster its position as a key player in the early childhood and under-15 market.


The privately held Earlychildhood has 16 years of experience as a manufacturer and direct marketer of early-childhood products. The company mails more than 2.5 million catalogs per year, runs a 12-year-old Earlychildhood News trade publication, has 50 field sales representatives and targets 90,000 early-learning centers.


More importantly, Earlychildhood last year bought Educational Products Inc., Dallas, a school fundraising company that touches nearly 1 million children.


"For us, that's a lot," said Al Noyes, executive vice president of sales and marketing at SmarterKids. "On the economics side, we will have a very cost-effective, scalable infrastructure."


It also helps that Earlychildhood claims profitability. Revenue for the nine months through September is estimated at $65 million, though profit was not disclosed.


By contrast, SmarterKids posted third-quarter sales of $1.51 million, overshadowed by net losses, excluding noncash compensation of $6.4 million. But sales for the third quarter were up 109 percent versus the same period last year, and repeat customers accounted for 49 percent of all revenue.


Once merged, William E. Simon & Sons Private Equity Partners, Los Angeles, an equity fund that is currently the principal shareholder in Earlychildhood, will become the largest stockholder in a new unnamed entity.


"Obviously what they're doing is scooping up the expertise that SmarterKids.com has with direct-to-consumer selling over the Internet," Wyman said, "and it looks to me to be a smart move for Earlychildhood.com, that it perhaps expects to gain some of the competencies that SmarterKids.com has."


In a related development, Noyes will take over as CEO of the new combined entity. David Blohm, the current president/CEO will resign and staff will be reduced to avoid overlap, Noyes said.


SmarterKids' decision to merge coincided with news last week that online retailer eToys.com, Santa Monica, CA, had closed a $40 million round of funding from a subsidiary of Wells Fargo & Co.


Barely the category leader online, eToys now faces tremendous competition from Toysrus.com, San Francisco, and Amazon.com, Seattle.


Toysrus.com and Amazon inked a 10-year deal in August for a co-branded online toy store. Toysrus.com will identify, buy and manage inventory. Amazon will offer site development, order fulfillment and customer service.


The union between Toysrus.com -- majority-owned by Toys "R" Us Inc., the No. 2 offline toy retailer after Wal-Mart Stores Inc. -- and Amazon aims to sidestep possible fulfillment issues that dogged Toysrus.com during last year's holiday season.


Noyes hopes that SmarterKids' alliance with Earlychildhood will similarly plug all shortcomings in the business model. More critically, it should stanch the bleeding.


"I think there's no doubt [with the merger that] the combined companies will get to profitability, we anticipate, with no additional capital," Noyes said.
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