Make Way For The New Toys On the Block!

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When console video games first achieved mainstream success back in the 1980s, some investors believed that traditional toy makers such as Mattel (NASDAQ: MAT) and Hasbro (NASDAQ: HAS) were doomed. They thought that boys would abandon their action figures to spend more time with Mario and Link. However, the toy industry proved those bearish critics wrong, and physical toys continued to sell well over the next three decades.

As a kid of the late 1980s, I owned my fair share of G.I. Joe and Transformers action figures, even though my friends and I were also hopelessly addicted to 8-bit Nintendo and Sega games. This resilience of toy makers in an increasingly digital age is simple to explain - growing kids love to use their imagination just as much as they love engaging in scripted digital adventures.

The new conflict between toys and video games

Today, the dormant decades-long conflict of toys versus video games has returned, after earnings from Mattel and Hasbro revealed a decline in sales of toys for boys compared to stronger sales of toys for girls. Much of this decline was attributed to the new threat of mobile social gaming, which has made portable gaming a much more social affair than it was in the past. Therefore, the toy industry is now engaged in a contest of tug-of-war against the video game industry for control of the lucrative boys’ market.

Mattel and Hasbro have signed deals with Rovio and Zynga, respectively, to release board games based on their popular Angry Birds and Farmville franchises in an effort to recapture the interest of boys who spend more time on smartphones and tablets than in a toy box. Hasbro, in particular, has invested heavily in movie franchises such as Transformers, G.I. Joe and Battleship to garner interest in its aging toy and game lines.

However, despite Mattel and Hasbro’s best efforts to win back the boys, a new threat has emerged - hybrid interactive toys that can be merged into a video gaming experience, created by the largest video game publisher in America, Activision Blizzard (NASDAQ: ATVI), and the largest media conglomerate in the world, The Walt Disney Company (NYSE: DIS).

The sky’s the limit

Activision Blizzard, best known for its World of Warcraft and Call of Duty franchises, first released Skylanders in October 2011. Skylanders was a unique product, which merged physical action figures with a console-based video game. These action figures are equipped with NFC chips, which are placed onto a pedestal that “transports” the toy into the video game. This allows gamers to collect and trade physical toy collections that can interact with each other in a digital environment. In other words, Skylanders took the card-collecting competitive frenzy of Pokemon and Yu-Gi-Oh! and straddled it across two different markets.

To date, only two supported games have been released - Spyro’s Adventure in 2011 and Skylanders: Giants in 2012, but total sales of the franchise hit the $1 billion mark in February, 15 months after its initial release. That’s a considerable feat for a company that generated $4.76 billion in annual revenue in 2012.

To infinity and beyond

This caught the attention of Disney, which is preparing to release Infinity, a similar product that allows consumers to place their favorite Disney and Pixar action figures into a digital world. Figures placed on the physical pedestal launch their own programmed playsets in the game world.

While Disney's idea sounds similar to Skylanders, Infinity takes the formula one step further by offering an open-ended sandbox mode, where users can play with a virtual toy in the digital world, combining racetracks, soccer fields and other pieces to create their own mini-game playgrounds. Different combinations of pieces and characters can yield dramatically different results. 

Infinity’s creators claim that the idea for the toy box came during the filming of Toy Story 3, and the influence is clear - just like Andy, gamers can play with toys in any way they choose. Game worlds can be collaborated on, and the virtual playgrounds can be saved by the session host.

Disney is counting on Infinity to turn around its Disney Interactive Media division, which is still operating at a loss, despite an 8% year-over-year revenue increase last quarter. Disney has notably scaled back on its video game operations, closing down Lucasfilm’s Lucasarts video game division and handing over the reins of its Star Wars game franchise to Electronic Arts.

If Infinity can replicate some of the success of Activision’s Skylanders when it is released this summer, then Disney could have a big hit on its hands and the segment could finally return to profitability.

The Foolish Bottom Line

Kids are lucky these days. Not only do they play some of the most graphically polished video games in history, but they also get interactive hybrid toys that blur the line between physical and digital toys.

Exciting times for kids also create exciting opportunities for investors. Activision Blizzard and Disney, which both generate their core revenue elsewhere, have very little to lose and plenty to gain if Skylanders and Infinity succeed. Meanwhile, I wouldn’t be surprised if Hasbro and Mattel, which are looking for ways to stay cool and relevant with young boys, started creating similar products of their own.

Even though the battle has evolved, human nature remains the same. Whether or not it's a cardboard box being spilled on a bedroom floor, or fancy NFC-equipped figurines being placed on console-connected pedestals, kids will always love to play and create new worlds, and there will always be a market for it.  

It's easy to forget that Walt Disney is more than just the House of Mouse. True, Disney amusement parks around the world hosted more than 121 million guests in 2011. But from its vast catalog of characters to its monster collection of media networks, much of Disney’s allure for investors lies in its diversity, and The Motley Fool's premium research report lays out the case for investing in Disney today. This report includes the key items investors must watch as well as the opportunities and threats the company faces going forward. So don't miss out -- simply click here now to claim your copy today.

Leo Sun owns shares of Walt Disney. The Motley Fool recommends Activision Blizzard, Hasbro, Mattel, and Walt Disney. The Motley Fool owns shares of Activision Blizzard, Hasbro, and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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