Morten Vang Pedersen

Valuation of LEGO Group
Copenhagen Business School

MSc Finance and Strategic Management
June 2013
Author:
Morten Vang-Pedersen
Supervisor:
Peter Staudt
Number of pages: 76
Number of characters: 175313
1
Author Statement
2
Executive Summary
The purpose of this thesis has been to estimate a fair value of the LEGO Group as of December 31st 2012,
with the perspective of an investor or prospective buyer.
The valuation is based upon strategic and financial analysis, as these allowed for the necessary forecasts to
be estimated.
The strategic analysis applied different models in regards to three levels of strategic analysis. The PEST
model was applied for the macro environment analysis, Porters for the industry analysis and the VRIO
framework for the internal analysis. LEGO’s primary revenue is made in Western Europe and North
America, but while LEGO does not experience significant growth on the Western European, it has
experienced growth of more than 20% in 2012 alone on the North American market. LEGO’s growth in
emerging markets was significant, but as the total sales in the regions were of a lesser degree, the impact was
big.
In general the analysis portrayed a bright future for LEGO, due to a strong brand, an optimized operating
model and plenty of opportunity for growth
The financial analysis showed LEGO has had strong sales growth, decreasing costs and thereby increasing
profit margins, effectively showcasing the complete turnaround since 2004. LEGO’s ROIC and ROE were
found to be much higher than its peers, as both Mattel’s and Hasbro’s financial were dissected.
These two chapters’ findings were applied to forecast future performance for LEGO, as both the income
statement and the balance sheet were budgeted for the forecast period. The forecasts show continued sales
growth, although at a decreasing rate, while costs are expected to increase gradually.
The DCF and EVA models were applied to estimate the fair value of the LEGO Group, resulting in a value
of 114.607,5 million DKK. The value is substantial as it is far higher than the enterprise value, based upon
shares and share price, of market leader Mattel.
A sensitivity analysis and multiples comparisons analysis were conducted in order to critically asses the
result of the valuation models. LEGO’s value was found to be sensitive to changes in WACC, in particular
the cost of equity, which influences LEGO’s WACC by 85,32% due to its capital structure. The multiples
comparisons showed that LEGO was valued very highly by the thesis, but this has to be adjusted for the
peers’ bad match in sales growth with LEGO, as their sales growth is much lower.
The thesis estimates that the found value of 114.607,5 million DKK is a representative assessment of
LEGO’s value as of the 31st of December 2012.
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Table of Contents
Author Statement ............................................................................................................................................... 2
Executive Summary........................................................................................................................................... 3
1. Introduction ............................................................................................................................................... 8
1.1 Problem Discussion ................................................................................................................................. 8

1.2 Research Question ................................................................................................................................. 10
1.3 Structure of the Project .......................................................................................................................... 10
1.4 Methodology.......................................................................................................................................... 12
1.5 Delimitation ........................................................................................................................................... 13
2. Presentation of LEGO Group .................................................................................................................. 13
2.1 History of Lego...................................................................................................................................... 14

2.2 LEGO’s Recent Financial Performance ................................................................................................ 18
2.3 CSR: .................................................................................................................................................. 19
2.4 Corporate Governance: .......................................................................................................................... 20

2.4.1Ownership........................................................................................................................................ 20
2.4.2 Board Composition ......................................................................................................................... 20
2.4.3 Management ................................................................................................................................... 20
2.5 Products: ................................................................................................................................................ 20

2.6 Market situation ..................................................................................................................................... 22
3. Strategic Analysis .................................................................................................................................... 24
3.1 Growth Opportunity .............................................................................................................................. 25

3.1.1 Overlook ......................................................................................................................................... 25
3.1.2 American Market ............................................................................................................................ 25
3.1.3 European Market ............................................................................................................................ 26
3.1.4 Asian Market .................................................................................................................................. 26
3.2 Macro Analysis...................................................................................................................................... 27

3.2.1 PEST ............................................................................................................................................... 27
3.3Micro Analysis ....................................................................................................................................... 32

3.3.1 Porters Five Forces ......................................................................................................................... 33
3.4 Internal Analysis .................................................................................................................................... 38

3.4.1 Tangible Resources......................................................................................................................... 39
3.4.2Intangible resources ......................................................................................................................... 40
4
3.4.3 Organizational Capabilities ............................................................................................................ 42
3.5 SWOT .................................................................................................................................................... 43

3.5.1 Strengths: ........................................................................................................................................ 44
3.5.2 Weaknesses..................................................................................................................................... 45
3.5.3 Opportunities .................................................................................................................................. 45
3.5.4 Threats ............................................................................................................................................ 46
4. Financial Analysis ................................................................................................................................... 46
4.1 Peer Group ............................................................................................................................................. 46

4.2 Applied Accounting Policies ................................................................................................................. 47
4.3 Reformulation the Financial Statements................................................................................................ 47
4.3.1 Statement of shareholders’ Equity .................................................................................................. 47
4.3.2Balance Sheet .................................................................................................................................. 48
4.3.3Income Statement ............................................................................................................................ 49
4.4Profitability Analysis .............................................................................................................................. 49

4.4.1 Return on Equity............................................................................................................................. 50
4.4.2 Return from Financing Activities ................................................................................................... 51
4.4.3 ROIC............................................................................................................................................... 53
4.5 Risk analysis .......................................................................................................................................... 55

4.5.1 Operating Risk ................................................................................................................................ 55
4.5.2 Financial Risk ................................................................................................................................. 56
4.6 Part Conclusion ..................................................................................................................................... 56

5. Budgeting and Forecasting ...................................................................................................................... 57
5.1 Forecast Period ...................................................................................................................................... 57

5.2 Income Statement Forecast.................................................................................................................... 57
5.2.1 Sales Growth .................................................................................................................................. 57
5.2.2 Costs ............................................................................................................................................... 58
5.2.3 Tax Rate.......................................................................................................................................... 58
5.2.4 Unusual Items ................................................................................................................................. 59
5.2.5 NOPAT ........................................................................................................................................... 59
5.3 Balance Sheet Forecast .......................................................................................................................... 59

5.3.1 Net Working Capital Forecast ........................................................................................................ 60
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5.3.2 Net Non-Current Operating Assets forecast ................................................................................... 60
5.3.3 Forecasted Return on Invested Capital ........................................................................................... 61
5.4Forecasted Free Cash Flow..................................................................................................................... 62

5.5 Part Conclusion ..................................................................................................................................... 62
6. Valuation ................................................................................................................................................. 63
6.1 Valuation Models .................................................................................................................................. 63

6.1.1 Discounted Cash Flow .................................................................................................................... 63
6.1.2 Economic Value Added .................................................................................................................. 64
6.2 Valuation assumptions........................................................................................................................... 64

6.3 Weighted Average Cost of Capital ........................................................................................................ 65
6.3.1 Capital Asset Pricing Model (CAPM) ............................................................................................ 65
6.3.2 Cost of debt..................................................................................................................................... 69
6.3.3 Cost of Capitalized Operating Leases............................................................................................. 69
6.3.4 Capital Structure ............................................................................................................................. 70
6.3.5 WACC ............................................................................................................................................ 70
6.4 Terminal Period ..................................................................................................................................... 71

6.5 Discounted Cash Flow Valuation .......................................................................................................... 71
6.6 EVA Valuation ...................................................................................................................................... 72
6.7 Sensitivity Analysis ............................................................................................................................... 73
6.7.1 Risk premium for the Terminal period and Terminal Growth........................................................ 73
6.7.2 Cost of Debt and Cost of Capitalized Operating Leases ................................................................ 74
6.7.3 Market Risk Premium and Terminal Growth ................................................................................. 75
6.7.4 Beta Value and Terminal Growth ................................................................................................... 76
6.7.5 Summary of sensitivity analysis ..................................................................................................... 76
6.8 Multiples Comparison ........................................................................................................................... 77

6.8.1 EV/Sales ......................................................................................................................................... 77
6.8.2 EV/EBITDA ................................................................................................................................... 78
6.8.3 EV/EBIT ......................................................................................................................................... 78
6.8.4 P/E .................................................................................................................................................. 78
6.8.5 Valuation of LEGO Based on Peer Ratios ..................................................................................... 79
6.8.6 Summary of Multiples Comparisons .............................................................................................. 79
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6.9 Valuation – Part Conclusion .................................................................................................................. 79
7. Conclusion ............................................................................................................................................... 80
8. Perspectives ............................................................................................................................................. 82
Literature list: .................................................................................................................................................. 83
Appendices ...................................................................................................................................................... 86
Appendix 1 .................................................................................................................................................. 86
Appendix 2 .................................................................................................................................................. 87
Appendix 3 .................................................................................................................................................. 89
Appendix 4 .................................................................................................................................................. 94
Appendix 5 .................................................................................................................................................. 97
Appendix 6 .................................................................................................................................................. 97
Appendix 7 .................................................................................................................................................. 99
Appendix 8 .................................................................................................................................................. 99
Appendix 9 ................................................................................................................................................ 100
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1. Introduction
1.1 Problem Discussion

The world’s economy has experienced dramatic changes the past 5 years. The economic turmoil has resulted
in strained economies for countries around the world, threatening with a total collapse of large financial
institutions. This has provided companies with severe challenges, as consumer spending has declinedi. It
stands to reason that in such conditions consumers might substitute expensive products with cheaper
alternatives, compromising with. Despite the circumstances, several companies have been experiencing
growth and success the past 5 years, causing them to be of interest as a case study.
Through the course of my education at Copenhagen Business School, strategic analysis and financial
analysis have been an integral part of the curriculum. Further I was introduced to the concept of firm
valuation, which applies these tools to gauge the value of a company. I find it of particular interest to gauge
the value of a company, which has defied the circumstances and prospered in times of economic turmoil,
since this process will allow me to obtain an understanding of how the company accomplished that feat.
I have found LEGO to be of particular interest, as the company was struggling mightily in the early 2000’s
but has been able to turn it around and now is one of the top competitors in global traditional toys and games
market. As LEGO is an unlisted company, it entails some challenges due to the decreased accessibility of
information on the company. The valuation therefore necessitates a very thorough and careful process, in
order to achieve a fair value of LEGO. It is assumed that enough information is accessible to compute a
credible valuation of the company.
LEGO competes on the global traditional toys and games industry, with its primary focus on construction
toys. Below is the development of the different geographical markets within the industry.
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Figure 1.1 Traditional Toys and Games market sizes
and growth rates
90.000,0 0,3
80.000,0 0,25 Asia Pacific
70.000,0 0,2 Eastern Europe

0,15 World
60.000,0
USD Millions
0,1 North America

50.000,0
0,05 Western Europe
40.000,0
0 World
30.000,0 North America
-0,05
20.000,0 -0,1 Western Europe
10.000,0 -0,15 Asia Pacific

Eastern Europe
0,0 -0,2
2006 2007 2008 2009 2010 2011
Source: Own creation, Euromonitor
As depicted in figure 1.1 the traditional toys and games market globally grew at an average of 5,2% for the
illustrated period. The markets in North America and Western Europe have not experienced much growth in
the period, not even prior to the financial crisis, and are considered stagnant. LEGO operate primarily on
these two markets, it is however expanding in regions such as Asia and Eastern Europeii. The global
traditional toys and games market’s growth is primarily driven by emerging markets’ growth, in large part
the Asian market. The global traditional toys and games market suffered a setback due to the financial crisis
in 2008, but especially the Western European market was affected negatively as it dropped by 8,04%iii. The
Eastern European market has experienced tremendous growth, but was also severely affected by the financial
crisis. It has since returned to a growth higher than 15% annually, making it a prime target for toy
manufacturers.
LEGO produces the iconic brick-based construction toys in a time where children give up toys for video
games and online activitiesiv. LEGO has been able to establish themselves as the 3rd largest company in the
market with a market share of 5.6 % in 2011v, despite being on the brink of going out of business in 2004vi.
LEGO is considered a high end toy product, as the price and quality are both very highvii. Seeing that the
financial crisis has severely decreased consumer spendingviii and the fact that its primary markets are the
stagnant North American and Western European markets, one might think that LEGO had been experiencing
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difficulty for the last several years. Quite to the contrary LEGO has experienced organic growth and an
increasingly larger profit.
LEGO presents an interesting case, as it has been able to overcome diversity, economic distress and turn
itself into a successful company. Further the company is not listed and an estimate of the company’s value is
therefore not accessible, making LEGO very interesting to valuate utilizing the relevant theory.
1.2 Research Question

The main purpose of this thesis is to gauge the fair market value of the LEGO Group from the point of view
of a potential investor. Whereas a sale of LEGO as a whole is unlikely, it is always a possibility. Further it
LEGO could go public in the future making a valuation most relevant.
“What is the current theoretical fair market value of the LEGO Group?”
Supporting the main problem statement is these sub-questions. These will be analyzed and discussed
throughout the thesis.
 What strategic aspects are of interest to LEGO, and how do these influence the valuation of
the firm?
 Can LEGO continue to grow at its current pace or will it hit a “cap” in the different markets?
 Has LEGO been able to build a sustainable business model, considering the challenges it
faces?
 How sensitive is LEGO to market risk, substitutes etc.?
 What is the fair value of the company using the DCF and the EVA model?
1.3 Structure of the Project

This thesis has been separated into eight chapters. Each chapter will be described shortly following the
figure, which depicts the structure of the project.
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Figure 1.2
Chapter 1
Introduction
Chapter 2
Presentation of LEGO Group
Chapter 3 Chapter 4
Strategic Analysis Financial Analysis
Chapter 5
Budget and Forecasting
Chapter 6
Valuation
Chapter 7
Conclusion
Chapter 8
Perspectives
Chapter 2
Following the preliminary chapter the company will be presented . The presentation will both be quantitative
and qualitative, thereby creating an understanding instrumental to the valuation.
Chapter 3
A strategic analysis will be performed on LEGO and its context, also applying knowledge gained in the
former chapter. The main goal here is to determine LEGO’s potential for future value creation. The potential
for growth in the different markets will be analyzed. The micro-environment will be analyzed with the
Porters Five Forces model, displaying the competitive situation in the industry, LEGO’s macro-environment
will be analyzed with the PEST-model, the VRIO framework will be applied to supply an internal analysis
and the chapter will be concluded with the SWOT-model.
Chapter 4
The goal of this chapter is to reveal the company’s true performance. The financial statements will be
dissected, hereby making them applicable for analytical purposes. The dissected values will be the base of
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the profitability analysis. This analysis strives to reveal deficiencies and gauge what has been the key driver
of the company’s performance in the analyzed period.
The chapter also provides an overview of key figures, the financial state up till today and historical
performance.
Chapter 5
In this chapter the future performance of LEGO will be projected for the forecast period of ten years,
providing a forecasted income statement, balance sheet and free cash flows.
Chapter 6
First the WACC level will be decided through thorough analysis. The thesis will then apply two different
valuation models to gauge the value of the LEGO Group, the DCF model and the EVA model. Lastly a
sensitivity analysis and a multiples comparisons analysis will be conducted.
Chapter 7
This chapter will summarize the thesis and highlight the main objects and results.
Chapter 8
As the thesis has been written over a long period of time, it was found necessary to make a constraint date,
after which new information was disregarded. Current developments after the cut-off date have however still
been followed, and this chapter will use the new information to put some perspectives on the results found in
the thesis.
1.4 Methodology
This section will illuminate methodical considerations in the thesis. The basis for my data collection will be
depicted and the data’s validity for the thesis will be evaluated.
The thesis is written from an external point of view, the view of a prospective investor. Therefore, only
external available information has been applied to conduct the valuation. This choice stands to reason, as it is
assumed that a prospective investor would typically only have access to secondary data. While it can be
assumed that most of the data collected is correct and objective, primarily due to the nature of selected
sources, the thesis will at all times take a critical view.
Various models, theories and frameworks have been applied to obtain a complete overview of LEGO and the
industry in which LEGO competes, thereby allowing a thorough analysis. Both quantitative and qualitative
are applied in order to answer the research question satisfyingly.
The thesis applies models based on the frameworks found in “Valuation: Measuring and Managing the Value
of Companies” by Koller, Goedhart & Wessels (2010), “Contemporary Strategy Analysis” by Grant (2010),
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“Financial Statement Analysis” Plensborg & Petersen 2006 , “Financial Statement Analysis and Security
Valuation” by Penman’s (2010) and “Regnskabsanalyse og værdiansættelse” by Sørensen & Elling’s (2005).
The thesis will be an intensive analysis of an individual unit focusing on the developmental factors in
relation to context. Therefore thesis will follow one of the three main approaches of an analysis (Yin, 2009),
which is the case study approach.
1.5 Delimitation
Throughout the work process it has been necessary to assume certain delimitations, hereby achieving a
manageable amount of information and analysis.
To answer to problem statement most accurately this thesis has focused its attention on the most important
factors. A considerable limitation in the thesis is the limitation of secondary information on the company,
which is primarily caused by LEGO A/S not being a public company. As the scope of the thesis is to gauge
the value from an investor’s point of view the thesis has chosen not to try and gain insider knowledge
through confidential interviews.
LEGO Group A/S consists of many subsidiariesix, often in different markets with different sets of parameters
being of importance. Therefore the thesis has chosen to look upon LEGO A/S as one entity, this also stands
to reason as the subsidiaries does not account for a major part of LEGO A/S total value and further will not
be a primary driver for future value.
The aim of the thesis is to do a valuation of LEGO A/S as of 31st December 2012 therefore all information
from beyond that date is excluded from the thesis.
There are several different models and theories, which can be applied in the process of a valuation, and it is
acknowledged that other models might have been appropriate for the thesis, but due to the limited size of the
thesis, the models found to be best applicable have been applied. The chosen models have certain limitations
but are widely used and accepted as valuation tools. The thesis will not use time and space on exploring and
analyzing the models, instead using them as tools to gain the necessary insight and information needed for
the valuation of LEGO A/S. Further the thesis will mainly refer to LEGO Group as LEGO, but when deemed
appropriate the full name will be used.
2. Presentation of LEGO Group

In order to obtain a credible and satisfactory estimate of the value of LEGO, a thorough understanding and
evaluation of all key aspects is needed, as it serves as the foundation of the predictions and expectations,
which comprises a vital part of the valuation process. Therefore an ample analysis and understanding of the
13
company is crucial as well. The next section will present LEGO’s history, the current state of LEGO and
delve into certain aspects of LEGO and its surroundings, critical for the later valuation.
2.1 History of Lego

In 1932 Ole Kirk Kristiansen (OKK) founded the Danish toy company LEGO in Billund, Denmarkx. The
company name was created by combining the first to letters of each of the Danish words “LEG” and
“GODT”. OKK, unknowingly, chose a company name, which in Latin means “I assemble”xi, which is quite a
coincidence considering the product LEGO’s end product. OKK’s motto was “The best is not good enough”,
which he incorporated into LEGO’s values. To this day the motto is still at the core of LEGO’s values. The
core message of the motto is that LEGO will never stop trying to improve its products, working
environments etc.
LEGO started off producing toys made of wood, but started experimenting with plastic toys in 1947. In 1949
it launched its first plastic building blocks, which encouraged children to use their imagination when playing
and go exploring in their own universexii. A year later OKK’s son Godtfred Kirk Kristiansen (GKK) took
over the business and 5 years later LEGO launched “LEGO system in playing”. The concept underlined the
importance of children learning through playing.
GKK continued to expand LEGO’s product portfolio throughout the 1960’s, as he introduced LEGO trains
with small motors and launched LEGO DUPLO and thereby started adapting LEGO’s products to different
age levels. The increase in business activity in the Billund area, primarily due to LEGO, resulted in the
Billund airport opening in 1964. A few years later in 1968 LEGO opened its first theme park, LEGOLAND
in Billund, Denmark.
In the 1970’s LEGO introduced the LEGO figures, which resembles very small dolls, further expanding its
product portfolio. This new aspect of the LEGO product portfolio created new opportunities to market and
sell its product, as it now combined its product with the opportunities of role-playing and personality. Later
in 1978 GKK’s son Kjeld Kirk Kristiansen (KKK) further systemized and optimized the concept of learning
through playing by creating new product programs, which put an emphasis on stimulating the child’s
creativity and imagination.
A year later, 1979, KKK was appointed CEO, and thereby took over from his dad, GKK. KKK continued the
aforementioned systemization and worked hard on optimizing it. KKK and GKK were often in disagreement
on how LEGO should be run and what the goals were for the company.
Through the 1980’s LEGO started collaborating with MIT on subjects such as learning processes and
technology, which gave LEGO an opportunity to be cutting edge in its industry and the ability to introduce
new products used for educational purposes.
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The 1990’s marked a decade in which LEGO introduced numerous new products resulting in a wide spanned
product portfolio. Additionally LEGO opened a new theme park in the UK in 1996. Through the
aforementioned collaboration with MIT, LEGO introduced a system called LEGO MINDSTORMS, which
provided children the opportunity to create and program intelligent LEGO models. In 1993 KKK had to
leave his position at LEGO due to health issues. He returned in 1994 with renewed energy and a new
strategy called Compass Management. The idea was to motivate and stimulate the employees of the
organization to become self-thinking and responsible. xiii
There was, however, a growing sense within LEGO, that the company had some serious issues. Sales were
not growing and had stagnated around 1995xiv. It became clear that KKK’s initiative, Compass management,
had failed, the employees had not changed their behavior and something had to be done. When LEGO
published its first annual report in 1997, the public became aware that LEGO was experiencing some
problems with significant drops in profits and stagnation in sales.
In 1998, trying to counter the impending crisis, KKK hired Poul Plougman (PP) as his CFO. The plan was to
cut down on expenses and create a lean company; the plan was called “LEGO fitness”. The same year LEGO
made a deal with Lucasfilm Ltd, providing LEGO with the rights to market a new LEGO series with a Star
Wars theme, which would later be a success. The financial distress did not stop LEGO from opening a new
theme park in 1999 in California, USA, as KKK was a strong believer in the parks.
However, LEGO’s financial struggles continued, as in 1998 it had a deficit for the first time since 1945,
stressing the declining state the company was in. 1999 marked a year of optimism; it seemed that a savings
round of 1 billion DKK provided by “LEGO fitness” and a round of firings along with the success of the Star
Wars line had changed the fortunes of LEGO. The result was a profit of 274 million and everybody seemed
to believe PP had been able to turn around the company. In 2000 LEGO’s woes returned and it had a
company record deficit at 863 million DKK. PP had become COO and no longer focused on financial control
and analysis, he now tried to become as close as possible to KKK, trying to gain more influence on the
strategy of the company. A significant change of directors was made, as KKK took a step back in operations
and made all directors refer directly to PP. The directors were unhappy and tried to reason with KKK, but to
no end. Therefore several of them chose to leave LEGO, one even did it on the day of the announcement. PP
had become more and more powerful, while KKK was stepping into the background, believing PP to be the
right person to orchestrate the turnaround of LEGO.
The financial struggle did not keep LEGO from introducing new products, as it struggled to find ways out of
its struggle. In 2001 LEGO BIONICLE was introduced, which purpose was to mix action toys with
construction toys, and in the hopes of getting a share of the commercial success of the Harry Potter brand, a
Harry Potter line was launched.
15
Figure 2.1: LEGO Profit and Sales 1997-2011
20.000
15.000
DKK Millions
10.000
5.000
2007
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2008
2009
2010
2011
-5.000
Year
LEGO experienced some financial progress in 2001 and 2002 with profits of 366 and 326 respectively,
which could be credited to PP, but rather the reason was LEGO’s ability to ride along on the Harry Potter
success. Star Wars had saved the financial performance in 1999, and Harry Potter did in 2001. This was a
clear indication that LEGO was becoming dependent on licensing. LEGO’s distress was apparent in 2003-
04. The company incurred a major deficit of 935 million DKK in 2003 along with a heavy decline in sales of
26 %, indicated by figure 2.1. Clearly the action taken by PP to steer out the crisis had failed. In the end of
2003 KKK began preparing to take LEGO in a new direction, and in the start of 2004 PP was fired, and
Jørgen Vig Knudstorp (JVK) and Jesper Ovesen (JO), who had been hired as CFO in November 2003, now
became the defacto leaders of the company. It was, however, only the top leadership of the company that
knew this, while everyone else thought JVK and JO were in supporting roles of KKK, which significantly
weakened their authority within the company. JVK became the official number 2 in June 2004, when KKK
promoted him to COO, but it was not until the 31st of August 2004 that KKK stepped down officially and
JVK was appointed CEO by the board. This marked the first time LEGO would not have a CEO, who
originated from the Kirk Kristiansen family. KKK continued working on the board, where he was joined by
his son, Thomas Kirk Kristiansen, in 2007, and where both are still active to this day. JVK was a surprise
hire to industry observers, as many thought of JVK as a “rookie”xv. KKK had hired JVK due to his intimate
knowledge of him and the compliance of their values and view of the company’s future.
JVK was now faced with a challenge as LEGO’s future looked dark. Debt was high, liquidity was low and
now Danske Bank refused to loan LEGO any more money. JVK’s plan was in three stages: “Manage for
cash” (2004-2005), “Manage for value” (2006-2008) and “Manage for growth” (2009+)xvi.
16
JO worked out a restructuring deal regarding the debt, which included Nordea, SEB, Nykredit and SEB,
further LEGO had to loan 1 billion DKK from KKK’s personal savings. Then LEGO sold off the
LEGOLAND parks in 2005 for €375 million, while also acquiring a 22% equity stake in the new theme park
operator, Merlin Entertainment.
A lot of decisions were made regarding different product lines as JVK strived to streamline LEGO and find
the core of the business.
Industry leader, Hasbro, had started outsourcing manufacturing a long time ago and JVK felt that it was time
for LEGO to go the same route. The manufacturing costs of LEGO had explodedxvii and Bali Padda was not
able to explain it as forecasts and sales orders varied so much. LEGO chose Flextronics due to its experience
in molding. It was by far the hardest decision during JVK’s leadership, as JVK’s plan included letting 80%
of the staff on the factory in Billund go over the next three years.
JVK further wanted LEGO to focus more on satisfying retailers and making them profitable, as he believed
this would benefit LEGO and create more revenue. Many of the leaders within LEGO disagreed and were
afraid that LEGO would forget the consumers.
2005 marked a year with 505 million DKK in profitsxviii and sales of 7.050 million DKK. This was very
satisfying and could be credited to larger savings than expected and increased sales of the modified core
products. Further asset sales contributed to almost half of the year’s profits before tax. In 2006 the progress
continued as profits increased by 183 % and sales by almost 11 %.
Not all was well, however, as LEGO cancelled its contract with Flextronics between 2007 and 2008. The
relationship had proved troublesome as Flextronics had problems living up to the standards set by LEGOxix.
JVK admitted it had been a grave mistake not to consider manufacturing a core competence. Hundreds of
millions of dollars were now invested to rebuild LEGO’s own manufacturing capabilities. It, however, relied
on Chinese contractors to manufacture electronics and decorations. Emphasizing LEGO’s competence of
manufacturing is that LEGO has three people operating 64 machines, compared to factories in China where
often there a three people per machinexx.
JVK started reinforcing the LEGO culture, which had always been centered on good working relationships,
collaboration and trust. JVK also wanted to change the innovative approach in LEGO which entailed many
changes. JVK did not change the staff of designers; rather he employed a more disciplined work process for
them. The designers were introduced to a more critical and analytical approach to consumer data, they began
to use market research insights and became engaged with children and parents, and were even sent to live
with consumers from time to time. This work process has been widely successful for LEGO.
Organizationally, the innovative steps were employed in 4 groupsxxi: 1) Product and marketing development,
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which have around 100 designers. The goal is to keep the core product portfolio fresh and vibrant, e.g. by
licensing new brands. Its acceptance rate of ideas is approximately 80 %. 2) The Concept Lab which is a
smaller team, who comes up with ideas for new products. The lab has a very low acceptance rate, as it had
72 ideas turned down before it had 1 accepted. 3) Community, Education and Direct: This group is primarily
responsible for digital innovations. The group has around 2000 employees as it also manages and supports
digital experiences for schools, consumers, LEGO stores and online store. This group often works together
with the other groups. 4) The New Business Group is a group of 10 designers with freedom to experiment
with small ideas with limited sales potential.
Production planning was optimized and scenario planning was introduced to adjust for ups and downs in
demand. Lastly, LEGO was finally able to develop systems to gauge the manufacturing costs by specific
product and customer profitability.
As stated JVK wanted an emphasis on retailer satisfaction and he continued down that road. LEGO has been
able to achieve excellence in key account management, as it tailors its value proposition for the specific
customer. Some wants price leadership, others exclusivity etc.
LEGO has further improved the service level through its optimization of the manufacturing process. It has
increased the availability of products to retailers and tried to avoid having too many products sold out.
LEGO has been able to increase retailer margin from 19% in 2004 to 30% in 2009, which are most likely a
reason for the increase in shelf space for LEGO in a typical store from about 3 meters to almost 10 meters. If
LEGO takes care of the retailers, the retailers take care of LEGO.
JVK attributes much of the success of LEGO to the optimization of its complex operating model – system of
factories, distribution centers, packaging, inventory and shipping. And it’s a necessity that the model is
punctual, because as he states “If you don’t meet the 7 am cross docking window at Wal-Mart, they tell you
to come back the next day.” LEGO’s model had to be able to fit most or all of its retailers’ wishes and
demands, thereby enhancing the relationship, which in turn benefits LEGO greatly.
2.2 LEGO’s Recent Financial Performance

LEGO’s recent financial performance correlate with the success of JVK’s planned stages, as 2004 was the
turning point. The data is the raw data from the annual reports, as the revised data will be explored in
financial analysis chapter.
18
Figure 2.2: LEGO Group Sales and Operating
20.000,00
margin 30,00%
18.000,00
20,00%
16.000,00
14.000,00 10,00%
DKK Millions
12.000,00
0,00%
10.000,00
-10,00% Sales
8.000,00
Operating margin
6.000,00 -20,00%
4.000,00
-30,00%
2.000,00
0,00 -40,00%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Year
As depicted in figure 2.2 the operating margin increased greatly from -28,80% in 2004 to 16,54% in 2006
and up to 23,22% in 2010, which it has been around since. The figure also clearly illustrates how LEGO’s
sales have developed, increasing steadily from 2004 to 2008, and increasing significantly from 2008 to 2011.
LEGO’s sales are expected to continue to grow, though LEGO is adamant about the growth not happening
too fast, as organic growth is vital to continue having an optimized operatingxxii.
2.3 CSR:
LEGO signed the UN’s Global Compact in 2003xxiii and strives to be corporate socially responsible
according to its website. It should therefore seldom in a situation where it needs to correct behavior, process
etc. due to legislation since LEGO strive to be cutting edge in regards to almost all aspects of the company.
The Danish consumer agency scored LEGO negatively in accordance to CSRxxiv, primarily due to its
unwillingness to cooperate and let the agency visit factories. When it comes to suppliers breaking the law on
e.g. work hours in China, LEGO, however, has continuously demanded they live up to regulations and
stopped relationships with several suppliers. LEGO is very unhappy with its rating from the consumer
agency and claim it did not have time and resources for this particular study, while also claiming to invest a
lot of resources in CSR.
19
2.4 Corporate Governance:
LEGO A/S is a family owned business, and it strives to combine the strengths of being family owned with
good corporate governance for listed companies. LEGO realizes the weaknesses of being family owned, e.g.
handover risk, and are diligently preparing and implementing plans to mitigate these risks.
2.4.1Ownership
LEGO A/S is owned by third and fourth generation of the founding family Kirk Kristiansen; Kjeld Kirk
Kristiansen and his three childrenxxv. The ownership is handled through KIRKBI Invest, which is an
investment company, run by Kjeld Kirk Kristiansen, owning 75%, and the LEGO foundation, who owns
25%.
The ownership structure for LEGO A/S has both benefits and issues as KKK effectively has the power.
Therefore the identity of the owner is equally as important as the relationship between owner and
managerxxvi. As mentioned KKK handpicked his CEO and apparently have a good relationship with him.
After mismanaging the company for years it seems KKK has found the right man to run his company.
2.4.2 Board Composition

LEGO A/S has the typical European two-tier boardxxvii. The board consists of the 7 members from the
supervisory board and 4 members from the executive board. Of the 7 members, 3 are considered dependent
as two have ownershipxxviii, KKK and his son TKK, and the last due to being in the management of the parent
firm, KIRKIBI.
2.4.3 Management
Three of the four managers have been part of LEGO A/S for a long time, only the new CFO has not, as he
started in September 2012. Since JVK took over as CEO conditions have stabled, and it can be assumed that
these conditions will continue for the near future. There has been some replacing of managers during KVK’s
tenure, as he has tried to optimize the group.
2.5 Products:
LEGO A/S is the third largest manufacturer of toys & games in the world in regards to revenuexxix. It has
built up its product portfolio to a wide span of products to all ages, children from 2 years and up to the adults
who still like to play once in a whilexxx.
Its portfolio includes toys, games, videogames, movies, accessories as bags, clothes etc. Its core business is
toys, evolving around the brick, and games and therefore LEGO most often work with external partners on
its other products through different strategic partnerships or contracts.xxxi
LEGO has a wide array of products and they will shortly be outlined in this sectionxxxii.
20
DUPLO is a product for pre-school children, which translates to ages 2-6. The bricks are twice as large as
regular LEGO for both safety and handiness reasons. The product has been a part of the portfolio for many
years and can be bought as loose bricks or themed packs. LEGO promotes the product as a way to stimulate
and evolve children’s senses and skills.
“Bricks and more” is buckets or boxes with bricks and other parts. There are no instructions as to how the
pieces should be put together, only the imagination sets the boundary. “Bricks and more” primarily appeals
to customers who love to build in a free flow from the imagination.
Themed LEGO sets are boxes with operating instructions to create a pre-determined theme. This could be
ships, cars, castles, houses etc. Children can then play with the built model or alter it as they wish. In line
with the themed LEGO sets, LEGO has a line of licensed products, which are themed sets. These are among
others, Star Wars, Lord of the Rings, Cars. LEGO has had great success with these products, especially its
former Harry Potter line.
LEGO Mindstorms NXT is a product where children can design their own robots, built of LEGO bricks. The
robot can be voice controlled or controlled by a smart-phone. The possibilities are endless, as there are wide
array of different bricks, motors and sensors to combine.
LEGO Videogames are LEGO themed videogames licensed from other worlds children know. Among others
there are "Pirates of the Caribbean", Batman and Harry Potter games.
LEGO recently launched LEGO Games, which are board games combined with building with LEGO bricks.
The new launch has been a success so far and LEGO expect it to continue.
LEGO Technic is a building system which differs from the original LEGO bricks. Children can build a
miniature Formula 1 car, motorcycles, cranes and big trucks with lots of working functionalities. This series
is definitely more complex and add gears, axles, pins and beams to the equation.
“LEGO friends” is a brand new concept introduced in 2012. The sets appeal primarily to girls and LEGO has
successfully marketed the product to girls. LEGO made a big marketing push, spending almost 50 million
dollarsxxxiii, because as JVK said: “We want to reach the other 50 percent of the world’s children.”
Further LEGO has been experiencing with online games. In 2010 LEGO Universe, a MMO game, was
launched. It was however shut down in 2012 since it was not profitable. LEGO currently has an array of
small online videogamesxxxiv, which are related to its product lines.
21
2.6 Market situation
The global market of toys and games amounted to US$ 154 billion in 2011xxxv, where traditional toys and
games accounted for US$ 82 billion. The tradition toys and games market grew by 7,9% in 2011 compared
to 2010, the growth originating from emerging markets, as the North American market declined by 1,3% and
the Western European growing by 6,5% to get close to the 2008 level. Eastern Europe and Latin America
were the fastest growing regions in traditional toys and gamesxxxvi, followed closely by Asia Pacific, driven
primarily by India and China. By 2013 Asia is expected to overtake North American as the world biggest
market for traditional toys and games.
LEGO is firmly focused on developed markets, in particular the North American and the Western European.
The two regions accounted for 72% of LEGO sales in 2011xxxvii. LEGO maintains a very strong position in
the Germany, Scandinavia and the UK. The North American market is LEGO's second largest regional
market, but is the market with most growth in recent yearsxxxviii. LEGO has actually doubled its sales in the
market since 2008, as a result of the change in how it cooperates with retailers and opening LEGO stores. In
emerging markets LEGO is especially present in the Easter European market, where it was the market leader
of traditional toys and game. Asia and pacific are viewed more as opportunity markets and the opportunity
within these will be explored later.
Table 2.1: Traditional Toys and Games market leaders in percent

Rank Company 2008 2009 2010 2011
1 Mattel Inc 12,8 12,3 12,5 12,5
2 Hasbro Inc 8,6 8,8 8,4 8,2
3 LEGO Group 3,7 4,4 5 5,6
4 BANDAI NAMCO Group 2,4 2,7 2,8 3,1
5 Takara Tomy Co Ltd 2 2,2 2,3 2,7
6 Spin Master Ltd 1 1,3 1,5 1,5
7 MGA Entertainment Inc 1,6 1,4 1,5 1,4
8 Hallmark Cards Inc 1,2 1,5 1,5 1,4
9 VTech Holdings Ltd 1,1 1,1 1,1 1,1
10 Simba-Dickie Group GmbH & Co KG 1 1 1 1,1
11 Walt Disney Co, The 0,7 0,8 1,2 1
12 LeapFrog Enterprises Inc 0,9 0,9 0,9 1
13 Giochi Preziosi SpA 0,8 0,8 0,8 0,7
14 Geobra Brandstätter GmbH & Co KG 0,7 0,7 0,7 0,7
15 Ravensburger AG 0,6 0,6 0,6 0,6
16 JAKKS Pacific Inc 0,9 1 0,8 0,6
17 Mega Brands Inc 0,4 0,4 0,5 0,5
Source: Own Creation, Euromonitor
22
LEGO's market share of 5.64% in the traditional toys and games market in 2011, ranks behind only Mattel
and Hasbroxxxix, as shown in table 2.1.
Mattel is an American toy manufacturer. Its product portfolio is very wide, and includes Fisher-Price, Barbie
dolls, board gamesxl etc. Mattel announced in early 2012 that it will be launching a new line of construction
toys in co-operation with Mega Brandsxli, specifically Barbie construction dolls, as they seek to challenge
LEGO for the girls’ construction toys market.
Hasbro is also an American multinational toy and games manufacturer. Hasbro, too, has a wide product
portfolio, spanning from games like Monopoly and Trivial Pursuit to toys like my little pony and
Transformers. Hasbro have launched a new product called Kre-Oxlii, a construction toy themed upon the
movie Transformers. The toy is primarily big construction dolls of the transformers and is compatible, with
LEGO’s products. The product is a direct competitor to certain lines of LEGO's product portfolio.
These two American multinational companies pose a threat to LEGO in the long run, as they look to grab
market shares of LEGO's construction toys market.
Mega Brands is company, which produces plastic bricks like LEGO. Its concept is practically the same as
LEGO's, as its blocks match LEGO’s. It could be considered a copy product, but is not like the generic lesser
competitors who basically copies LEGO's products. LEGO has continually sued Mega Brandsxliii, and might
have slowed MEGA BRANDS’ progress, but has still lost in court. MEGA BRANDS has not been able to
catch up to LEGO, but it is number two on the market in construction toys. Mega Brands sorely lack the
brand LEGO has, and perhaps the know-how for an optimal production process. Mega Brands does,
however, pose a threat as its team-up with Mattel, provides capital, a known brand and more know-how of
large-scale operations.
23
Figure 2.3 : LEGO Share in Construction Toys in 2011
China
Taiwan
South Korea
Spain
Turkey
Japan
Mexico
Poland
Brazil
Germany
UK
USA
Netherlands
Russia
Sweden
0 10 20 30 40 50 60 70 80 90
Figure 2.3 depicts LEGO’s strong position in the construction toys segment in different markets. It remains
to be seen whether LEGO can keep these percentages up with the incoming competition in its segment.
Licensing is an agreement between a licensor and licensee. They agree to give the licensee permission to use
the licensor's material. In the toy industry it can be characterized as intellectual property or brands. Known
brands such as Star Wars, Harry Potter etc. are licensed out to the competitors, who in turn pay royalties to
the licensor. The toys and games industry is one of the most licensed industriesxliv. The reason is that
licensing has become very important in driving sales and launching new products in the industry. The
competitors utilize the already known brand, and market their product heavily reaching out to children
through heavy marketing campaigns. Licensing differs in its importance on the different markets, generally
licensing drives growth primarily on the North American, Western European and different countries in Asia,
including South Korea, Singapore, Indonesia and Thailandxlv.
3. Strategic Analysis
The previous chapter described important aspects of LEGO, its development over the y ears and the context
in which it operates in. This information will be utilized in this chapter to perform a thorough strategic
analysis, and subsequently in the thesis, as the information is influential in regards many aspects of the
valuation.
24
The strategic analysis is separated into five sections in order to create a complete understanding of the
different aspects in LEGO strategic context. The analysis will start by exploring the growth opportunities for
LEGO in the different markets. Subsequently the PEST framework will be applied, shedding light on four
key macro-environmental factors, which are out of direct control for LEGO, but directly affect LEGO and its
opportunities. In order to analyze the current competitive situation in the industry the Porters Five Forces
framework will be utilized, while to conduct an internal analysis of the company, the VRIO framework will
be applied taking a resource-based view.
Lastly a SWOT analysis is applied, as the framework sums up the strategic findings and evaluates which
strengths, weaknesses, opportunities and threats are of importance for future performance for LEGO.
3.1 Growth Opportunity

This section will explore the outlook for LEGO in different markets, highlighting the opportunity for growth.
The situation will be shortly outlined before a more in-depth exploration of the markets will take place, while
analyzing LEGO’s opportunity within the markets. As LEGO does not disclose geographical sales numbers,
much data relies on second hand sources and in other cases, data has not been available.
3.1.1 Overlook
The American market has been the largest market for many years, but slow growth on the market means that
both Europe and Asia will overtake it in a few years. The American market had a value of 21,2 billion USD
in 2011xlvi, while Europe and Asia had values of 21,1 billion USD and 19,2 billion USD respectively. The
American market has had a compound annual growth rate (CAGR) of -0,2%xlvii from 2007 to 2011, showing
a negative growth in the period, primarily due to the financial crisis. The European and Asian market both
had positive growth in the period, with CAGR’s of 2,2% and 6,5% respectively. As these two markets are
expected to grow at approximately same rate the next 5 years, 2,1% for Europe and 7,5% for Asia, and the
American market is expected to grow by only 0,1% , it becomes obvious that both markets will overtake the
American market and that Asia will soon be the biggest market for traditional toys and games. Europe,
meanwhile, will be the second biggest market, driven especially by the growth in Eastern Europe.
3.1.2 American Market

LEGO has had significant success in the last 8 years in the American market, as it has posted double-digit
sales growth for eight consecutive yearsxlviii. LEGO’s growth in the market is not driven by the markets
growth, evidenced by the market’s decline in the period. Rather the growth is achieved by outperforming or
stealing market shares from its competitors. Thus the market still presents LEGO with a substantial growth
opportunity. The opportunity is however capped, as the market is stagnant and due to the fact that it must be
presumed that at a point in time LEGO will reach a saturation level in the market for its product. Due to the
25
diverse nature of the industry, LEGO’s product, the changing demands of children and a dozen of other
factors it is not possible for LEGO to gain control of the industry with its current setup.
In the first half of 2012 LEGO had sales growth of 23%xlix, indicating that a saturation level for LEGO’s
products is not imminent. In 2011 91%l of LEGO’s sales on the American market were to boys, which rate
can be assumed to be similar in other markets, therefore LEGO has begun to try and develop products to the
girls. The new LEGO FRIENDS product for girls is showing promise and constitutes a significant growth
opportunity. Therefore the market presents LEGO with a notable growth opportunity and LEGO could
continue to steal market shares, as its competitors scramble to enter the construction toys segment to defend
their market shares.
3.1.3 European Market

The European market is a core market for LEGO, and in 2011 LEGO had sales growth of 10%li. LEGO has
been present in the market for many years and has, in markets such as Germany and UK, reached a saturation
level for its product, making growth through its traditional products difficult. Therefore its growth is driven
by other factors. The growth can be attributed to the success of LEGO FRIENDS for girls in the entire
market and growth in Eastern Europe.
Russia is LEGO’s fourth largest country-market measured on sales after the markets in America, Germany
and Great Britainlii, and clearly the largest market in the Eastern Europe segment. Therefore growth in this
market will be an instrumental driver for total growth in this region. In 2011, the Russian traditional toys and
games market grew around 12% and LEGO had around 1 billion DKK in sales in the market. For the last 2-3
years LEGO has had sales growth around 35%liii in Russia. LEGO has spent several years and many
resources gaining acceptance and establishing themselves in the Russian market, which can be troublesome
due to the political climateliv, and is now positioned to take full advantage of the growing market.
LEGO’s potential for growth in Europe primarily consists of its opportunities in Eastern Europe and the
potential for the LEGO Friends product. LEGO has invested heavily in new plants in Eastern Europe and it
would be logical if LEGO were to open plants even closer to or in Russia in the near future to handle the
increasing demand.
3.1.4 Asian Market

The Asian traditional toys and games market has had riveting growth compared to Europe and America.
Sales in Japan accounted for 34,8 % in 2011 while China accounted for 32,9%lv and India for 11,3%. Of
these 3 major countries LEGO is most popular in Japanlvi with a market share of 46% in the construction toys
segment, and while only possessing 5% in China.
26
LEGO has had 50% sales growth in the first six months of 2012 in Asia and more than 100% a month in
China.lvii While the growth in especially China seems staggering, LEGO does not expect China to be as good
a growth opportunity as Russia, as LEGO projects the potential of the Chinese market to be half of Russia
primarily due to culture differenceslviii. Half of Russia, however, constitutes a significant growth opportunity,
as LEGO projects the potential of Russia to be around 6-8billion DKKlix. LEGO has made the decision to
build a plant in China, which will begin construction in 2014 and will supply around 70-80% of the demand
in the Asian region in 2017lx. Having a factory closer to the end market will significantly lower costs of
transportation etc. As China develops a larger middle class, there is a possibility for a significant increase in
demand for LEGO’s products.
In several Asian countries, parents view toys as an obstruction to their children’s school studies, constituting
a significant culture differencelxi. Therefore LEGO brands its products heavily as innovative and intellectual
products, from which children can enhance and train certain skills.
In Japan and South Korea LEGO is popular, its popularity increased by the toys’ ability to make children
learn while playing. It is assessed that LEGO can achieve decent growth, but not major, as it has already
been in the market for many years.
The market in Asia will be world’s biggest sooner rather than later, and therefore has major growth potential.
LEGO will have to adapt to the cultural values and brand its product in specific ways, to be able to tap
deeply into the vast potential of the market.
3.2 Macro Analysis

This analysis will explore the factors on the macro-environmental levels, which affect the traditional toys
and games industry, and in particular LEGO. These factors are influential elements, which cannot directly be
changed by competitors in the industry. The focus will tend to focus more on the North American and the
Western European market as these constitute the main part of LEGO’s sales, but emerging markets are of
note as these constitute growth opportunitieslxii. This analysis will be simplistic version, focusing on the key
factors, as the complete macro-environment is vast.
3.2.1 PEST
The PEST analysis will be in 4 parts, as there are 4 factors; Political, Economic, Social and Technological.
Each part will contain analysis in regards to the societal factors which influence the toys and games industry.
3.2.1.1 Political:
The political environment has a big influence on a company’s short- and long-term strategic and operational
decisions. Further it directly influences the earning opportunities for competitors through changes in
corporate taxes, tariffs, labor laws, environmental laws, education systems etclxiii.
27
The traditional toys and games market is highly regulated on the Western European and North American
markets. The competitors manufacture products for children; hence there is a high emphasis on security and
what the products are made from. In the EU every country has to abide by the rules set by the union, which
are based on three elements; The toy has to live up to the safety demands in the EU’s “Toy Safety
Directives”, the manufacturers have to be able to document that the their product lives up to these standards
and the toy has be marked with a CE mark, the company’s name, address and potential warningslxiv.
Further the legislation on phthalates became of importance to the industry. Phthalates are used to increase
plastics’ flexibility, transparency, durability and longevitylxv. The use of it has been severely limited since
1999 in EU and since 2008 in USA. 3 phthalates, DEHP, BBP and BPH, have been restricted to 0,1% of the
plasticized part of the product, while the 3 other, DINP, DIDP and DNOP, have been restricted to 0,1% in
toys, which children can put in their mouth. The result of such legislation is increased costs, as products can
be called back and production could be forced to find a substitute for phthalates etc.
Similarly there was discontent in many industries when talks about banning bisphenol A, a chemical used to
harden plasticlxvi, arose in the EU. A ban would greatly affect the toy industry as it is widely usedlxvii, LEGO
in particular uses it. It ended up not affecting the toy industry as the ban only concerned products, which are
meant to be put in the mouth, but it does illustrate how competitors are subject to risk from legislation.
LEGO is a multinational corporation, operating in countries around the world. LEGO is most sensitive to
legislation and governmental regulations in its biggest markets and in the countries LEGO manufacture its
products. If LEGO violates laws and legislation, LEGO is subject to sanction, which could lead to increased
cost.
The bulk of LEGO’s sales originate from the North American and the Western European marketslxviii, while
its production is primarily in Denmark, Czech Republic, Mexico and Hungarylxix. LEGO is building a new
factory in China, which makes LEGO’s exposure to political factors in China greater. China’s commercial
law is undergoing a fast change, as it tries to make its commercial laws comparable to the Western
commercial lawslxx, but the process is yet to be completed, and many uncertainties remain. In 2011 22 billion
of 36 billion LEGO elements were produced at its factory in Billundlxxi, which means, that while LEGO has
factories in inexpensive labor countries, most of LEGO’s production is still positioned in Denmark, and
therefore exposed to the EU’s and, in some part, Danish legislation. The political climate in EU is rather
stable, which decreases LEGO’s exposure to political instability, but also subjects LEGO to highly
regulatory legislation on toys. The US market is similar to the Western European, although it tends to be a bit
behind the EU in the form of legislation to safeguard consumers, as evidenced by the 9 year lag in restricting
phthalates.
28
The risk of political instability is much more prominent in the inexpensive labor countries LEGO operates in.
Further LEGO utilizes third party manufacturers throughout Asia, in which the risk of political instability is
present as well. Operations could be severely impacted if disease or political unrest were to strike the region.
As Russia is becoming an increasingly more important market for LEGO, the risk associated with the
political environment increase as well. Other emerging markets present the same risk, though perhaps not to
the same degree, why LEGO must navigate carefully and attempt to follow all written and unwritten rules in
countries with unstable political climates.
There been much discussion in Danish politics whether to raise or lower the corporate tax. A change will
have a direct impact on profits for LEGO, as LEGO is based in Billund, Denmark. More importantly,
according to JVKlxxii, is the Danish government’s investment in education as a highly skilled workforce is
very important for companies such as LEGO. The wages are so high, that the work force is required to be
very skilled in order to make up for the disadvantage in costs for wages. This is further emphasized by a
report by WEF, as it names restrictive labor regulations, tax rates and tax regulations as the most problematic
factors for doing business in Scandinavia.lxxiii
LEGO has tried to protect its product after the patent ran out in 1988. Many competitors have copied the idea
of the building blocks and LEGO continually has had to battle many in courts around the world. LEGO has
had mixed results, but has sometimes been able to limit the production of copy products. Many of the
competitors produce blocks which are compatible with LEGO’s own blocks, which mean they are a serious
threat. Therefore the courts are an important factor for LEGO, as LEGO continue to fight companies who
copy LEGO’s product. The specific competitors will be elaborated on later in the analysis.
3.2.1.2 Economic
Information regarding economic circumstances, in relation to the company, is imperative for management to
take the necessary precautions and action. Managers can adjust production if they foresee an increase or
decline in sales, thereby regulating inventory and avoiding unnecessary costslxxiv.
3.2.1.2.1 Raw Materials

Prices of raw materials can cause an increase in costs for a company and thereby influence the earnings. Oil
is a primary commodity in producing LEGO blockslxxv, and an increase in the price could impact LEGO’s
cost in the long run. LEGO controls the risk of rising prices of raw materials internally and is thereby
protected short term through contracts. However, an increase in price would have a negative influence, as it
would impact LEGO’s shipping costs and future contracts. As for energy LEGO has entered into electricity
derivativeslxxvi in order to hedge part of its future electricity consumption. The risk is not significant as the
impact is so small.
29
3.2.1.2.2 Gross Domestic Product (GDP)
As evidenced by figure 3.1, the global financial crisis had effects on all big markets, as all markets dipped.
Figure 3.1: Real GDP Growth

10,0
8,0
6,0
Asia Pacific
4,0
Percent
World
2,0
USA
0,0
Western Europe
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
-2,0 2017
-4,0
-6,0
The crisis made consumers much more aware of how they spend their money, which directly affected many
industries.
As mentioned, LEGO’s products are considered expensive quality toys; therefore it would be natural to
assume that when consumers are pressed economically, they would substitute to a cheaper product or not but
the product at all. Switching costs for the consumer, are nonexistent and the selection of toys enormous.
However, this has not been the case, as LEGO’s sales have soared despite the crisis. According to JVK, this
is because LEGO’s products are such small part of the consumers’ total consumption. Therefore consumers
will not choose this as an area to save. Another reason might be that parents will not save on presents for
their children, when the children are already influenced by a smaller budget, which cut into clothes, food etc.
It is unknown how LEGO’s results would have looked if the economy was booming, but it is safe to assume
that it would not have hurt LEGO’s sales. LEGO’s ability to defy the financial crisis is a very a positive
attribute as economic experts do not see an end to the slumping economylxxvii, but for LEGO’s current state,
this is not a problem.
3.2.1.2.3Interest and Exchange Rates

LEGO has significant net inflows in EUR, USD and GBP, as Western Europe and North America is its
primary markets. CZK, HUF and MXN account for the most significant exposure on the outflow sidelxxviii,
30
this is due to the fact that LEGO has factories in these countries and sales in the countries do not match up to
the costs of the plants. LEGO hedges against foreign exchange risk by derivatives such as forward contracts.
3.2.1.2.4 Demographic
As LEGO sells products for children lower birthrates could have a negative for LEGO’s growth.
Figure 3.2, Birth rates

18,0
16,0
14,0
Crude Birth Rates
12,0
10,0
8,0 North America
6,0
Western Europe
4,0
2,0
0,0
0 10 20 30
Past 30 years
In LEGO’s two core markets, North America and Western Europe birth rates have continued to decreaselxxix,
as depicted in figure 3.2. In Europe it has become known as the aging of Europe. The implications for LEGO
are that its primary target group, children in these two markets, will decrease, which could result in further
competition for the group. Implications, looking forward, could be that LEGO has to expand geographically
to keep growing.
3.2.1.3 Social
The social factor is of note in accordance to LEGO, as a few important trends have been noted by industry
observerslxxx. Today's children differ greatly from the children from just a few years ago. They often have
after school engagements and less unscheduled time where they can play. They are growing up more rapidly,
as younger and younger children are taking up technological toys and spending vast time on the internet.
Further they outgrow toys faster than prior generations, leading to an age-compression as they enter
adolescence earlier and therefore acquire adult-like consumption patterns. The age compression has withered
the group, in which children buy the most toys from 2-14 to 2-10 in the North American marketlxxxi. If
correct, these trends shrink the amount of children LEGO can market its product to.
31
As children have become more independentlxxxii, they have also achieved a greater influence on what toys
they get from their parents. In addition children have more money to spend. These trends compel competitors
in the toy industry to market directly to children, whereas in the past they would sometimes market their
product to the parentslxxxiii.
The thesis does, however, consider marketing to children something competitors have always done, as
children always have and most likely always will have an influence on which toys they get.
3.2.1.4 Technological
The technological advances affect all industries. Competitors are forced to be innovative in both product
development and cost handling. New production technologies keep streamlining production, thereby
lowering costs, and increasing competition, as competitors strive to achieve the best cost margins. LEGO has
invested vast resources to be cutting edge and are e.g. able to handle a large number of machines with few
employees. Further it has used the lean principles as a building block to strengthen its competitiveness now
and in the futurelxxxiv. The tolerance for error in production for the blocks is down to 1/100 mm, which attests
to the highly technological equipment needed in productionlxxxv.
The internet has become an integral part of most people's life, hence the necessity for competitors to be
present on the web and use it to their advantage. LEGO has tried many different approaches and actions
through the web and had mixed success. The internet has also shortened the distance between competitors
and consumers, and LEGO now has a web shop where consumers can buy its products online directly from
LEGO. LEGO needs to continue to try to find the best use of the internet for the company, as children will
continue using much time on the internet.
3.2.1.5 Criticism of PEST

The factors, described in this chapter using the PEST framework, all influence the LEGO Group. The
framework is vital to an analysis of the environment, in which LEGO is situated, but it does come with
certain limitations. It can be biased, as it depends on the person analyzing the environment and it does not
cover every single aspect of the environment. This thesis has however chosen to use the framework, as it has
been deemed that it covers the most important aspects of the environment.
3.3Micro Analysis
While the prior chapter focused on the macro environmental factors influencing the toys and games industry
in general, the following chapter will contain an analysis of the micro-environmental factors that influence
the industry. The analysis will focus on the North American and the Western European market as this is
where the bulk of LEGO's revenue is madelxxxvi, but will also include analysis from emerging markets as
these have been found to present a significant growth opportunity to LEGO.
32
3.3.1 Porters Five Forces
The analysis will be conducted through applying one of the most used frameworks for such analysis, Porter's
Five Forces framework. By understanding the competitive forces, and their underlying causes, the roots of an
industry's profitability will be revealed, while also providing a framework for anticipating and influencing
competition over timelxxxvii. When appropriate the thesis will focus the analysis on the construction toys
segment of the industry, in which LEGO operates.
Figure 3.3
Source: Porter 1979
3.3.1.1 Threat of Entry

The barriers of entry for the toys and games industry can be considered low, as new fad toys have
continuously entered the marketlxxxviii. Further, big retailers such as Wal-mart and Target have begun
backwards integrating some toys, as they already have lines of their own toys. The barriers are, however,
much higher when it comes to the different segments of traditional toys, as big companies are sitting heavily
on their own segment. The thesis will for this section focus more on the threat of entry to LEGO's segment of
the market.
While the process of manufacturing plastic blocks is not in general a vastly expensive or difficult process,
manufacturing high quality blocks, entering the market and becoming operational in it is. Extensive
investments in modern production facilities, as well as the acquirement of a high level of know-how is
needed if the entrant intent to be competitive in the global market. Therefore capital is vital in order to
33
establish oneself as a competitive company in the construction toys market. Economies of scale are barrier as
welllxxxix, the more you manufacture the more advantages you can possibly obtain. LEGO produced around
1.000 elements every second of 2010xc, and had by 2010 produced more than 485 billion elements, hence
economies of scale applies to them.
Brand can be considered a very important factor in LEGO's segment, and LEGO's brand is well renowned all
over the world, in particular in the western worldxci. Its brand has been an instrumental piece in its success. A
new competitor would be forced to spend extensive resources for marketing and branding, but a brand like
LEGO’s is impossible to imitate short term. This constitutes yet another major challenge, as building a viable
brand is difficult, time consuming and highly costly.
The majority of LEGO's sales are to retailers, who then sell LEGO's product to the consumers. LEGO has its
own LEGO stores and a web shop, which account for the rest of its sales. Even though sales through the
internet keeps rising, most parents still buy toys in stores, therefore to be a significant competitor one would
have to sell in stores, and not only online. A potential entrant would therefore need to establish channels of
distribution in order to competitively sell its product.
The big competitors in the toy and games industry are lurking to enter LEGO's segment, and the two biggest
have started to, as the market continuously grows. LEGO had double-digit growth on most of its markets in
2011xcii. The threat lies in the fact that these competitors already have the necessary distribution network, a
level of know-how in regards to large-scale production, a known brand and the capital to invest. Additionally
joint ventures or cooperation by competitors are a threat, as the small LEGO copying competitors could
potentially join a bigger competitor in the hunt for market shares, similarly to the Mattel and Megabrand
team up. LEGO does have a few competitors who manufactures building block systems in the original sense,
they are however mostly insignificant. But the threat from Mattel and Hasbro is significant if they were to
expand their operations within the market further, as they pose a threat to steal market shares. This threat of
entry is clearly more significant and should be rather imminent as the US market for construction toys grew
by 23% in the first six months of 2012xciii, while markets for other toys were mostly stagnant in the USxciv.
3.3.1.2Bargaining Power of Suppliers

The industry's primary suppliers are Chinese subcontractorsxcv. There is a high amount of these Chinese
subcontractors and they supply many different industries, hence the dependence level is low.
After LEGO's failed attempt to outsource production, it found out how its expertise in manufacturing was a
core competence and now it has most of its production in-housexcvi. Therefore its primary supply need is
plastic granules, which price is generally controlled by the price of oil. It does however also need electric
motors, transformers etc. These supply needs are not highly differentiated and combined with the fact that a
vast amount of potential suppliers are available, the result is a low dependence level. The switching cost of
34
suppliers is generally low as well, but for the more product specific elements such as motors for LEGO etc,
switching costs could be a little higher. The more product-specific the element is the more co-dependent the
supplier and buyer will be.
LEGO holds its subcontractors to high standards, as LEGO try to enforce its set of values. LEGO is
continually looking for the best possible subcontractors, and will let subcontractors go if they do live up to
the standards set by LEGO, both in relation to product standards and health and safety regulations for
employees etcxcvii.
Licensed products have become more and more popular in the toys and games industry, as children love to
play with characters they know from e.g. a movie or a book universe. Therefore the dependence is higher and
competitors must pay a premium to obtain the rights to manufacture the licensed products. These suppliers of
licenses have a strong bargaining power, as several competitors are interested in obtaining rights to a popular
children universe, e.g. Harry Potter.
The result is a low bargaining power for suppliers, however, the suppliers of themes for licensed toys possess
bargaining power, as many toy companies compete to get the contracts.
3.3.1.3 Bargaining Power of Buyers

The primary buyers in the industry are big retailers, e.g. of Mattel's total sales three retailers represented 38%
of itxcviii. LEGO does sell approximately 10 % of its sales to the consumers through its own stores and its web
shopxcix, but this section will primarily focus on the retailers, as they represent 90% of LEGO’s sales.
There has been much consolidation in the retail market through the last couple of decades on the North
American market and on the Western European marketc. Due to the consolidation, these big retailers
purchase in volume, providing them with negotiating leverageci. LEGO's products are unique and the
retailers cannot exchange it with a similar product and expect similar sales. The switching costs for retailers
can be expected to be low, as they can easily buy toys from other competitors. There will be costs of
constructing contracts and agency costs, but the costs are not considered significant. Buyers cannot easily
backwards integrate production of all toys, especially LEGO’s products due to the know-how and production
facilities required. However, as mentioned, major retailers have begun manufacturing their own toys. This
gives these big retailers some leverage, as they are less dependent of the competitors. The brand value of the
competitors’ products ensures them some leverage, as the retailers want to satisfy their customers, by making
the product the consumers want available to buy. The retailers, for whom toys is just a part of what they sell,
can still turn a profit without selling toys, as toys represent a small part of their total sales. For Toys' R' us,
Fætter BR etc. the dynamic is a bit different as they have a bigger need to have the big brands present in their
stores. The relationship for Fætter BR and Toys’ R’ us is deemed co-dependent, as if they were to stop
buying LEGO, it can be assumed that most consumers would look in the next toy-store or supermarket.
35
The lower the profits a retailer earns for a product, the less inclined the retailer will be to put it in prime
location in the store, and will further be more price-sensitive to the product. Therefore a good relationship
with retailers is valuable to competitors. Smaller retailers have less negotiating leverage, as they do not
purchase in bulk and often need the products from the big competitors, as their toys are what children
demand. Hence the buyer power and negotiating leverage for medium to small retailers is low. It is of course
in the interest of competitors, to a certain degree, to keep the products profitability good for the retailers, as
this will often result in higher sales totals.
Generally LEGO is in a good position due to its differentiated product, and none of the retailers, big or small,
want to be in a situation where they cannot offer the consumer the product they want. There simply is no
perfect substitute for LEGO yet, which is a major advantage for LEGO when it comes to negotiating
leverage. As mentioned, LEGO has worked hard on its relationships with retailers, fulfilling their needs and
wishes, in order to have a stable and profitable working relationship.
3.3.1.4 Threat of Substitutes

For the toys and games industry the threat of substitutes will be constituted of all other activities that take up
the time a child would normally play with a traditional toy. These include computers, cell phones, TV, video
games and online gaming.
As mentioned trends show that children spend more and more time with digital products, but LEGO
continues to grow and sell more and more, defying the trend. It could be argued that the digital impact is
capped, and that e.g. tablet game playing for children is more of a substitute for watching TV.
LEGO has incorporated technology in some of its products and has had many projects with online gaming,
video games etc, but most are still regular plastic blocks in different shapes and forms.
The threat of substitutes for the industry is high, but for LEGO it is considerably lower.
3.3.1.5 Competitive Rivalry

The industry is characterized by a handful of big competitors and a vast amount of smaller competitors. The
primary big companies, as described earlier, are Mattel, Hasbro, LEGO, BANDAI NAMCO and Takara
Tomy. These 5 are considerably bigger than the other competitors, which according to theorycii should
decrease the intensity of the rivalry, but the intensity is still considered high due to other factors.
As the saturation in the North American and Western European markets entails that the competitors will not
be able to increase their sales through natural growth in these markets, they are instead forced to compete for
existing market shares. The stagnant markets intensify rivalry and hurts profits, and competitors would be
wise to expand to emerging markets, which are growing at considerable ratesciii.
36
Figure 3.4:Traditional toys and games emerging
markets sizes
25.000,0
20.000,0
USD millions
15.000,0 Asia Pacific

10.000,0 Eastern Europe
5.000,0 Latin America
0,0
2004 2005 2006 2007 2008 2009 2010 2011 2012
Only the Asia Pacific market did not dip in the aftermath of the financial crisis, and all three continue to
grow, providing competitors with opportunity to expand, as evidenced by figure 3.4.
The circumstances in the 2 stagnant , North America and Western Europe, require a different approach, a
more aggressive and competitive strategy, of which innovation and brand awareness, as well as becoming
more lean, are examples of essential aspects that are influential in order to compete and steal market shares.
Competitors are constantly on the lookout for the next license opportunity from Hollywood etc., as these
have shown to be able make a difference and increase market shares.
The competitors compete on both homogenous and heterogeneous markets. The traditional toys and games
market consists of an infinite amount of toys, and can be considered as two marketsciv. On the homogenous
market, brand is irrelevant, while brand is crucial on the heterogeneous market. LEGO chiefly operates on
the heterogeneous market, where it utilizes its brand and differentiated product to dominate competition. The
differentiated product means that price competition is less likely to occurcv. The copycats of LEGO products
do sell at a lower price, but due to the brand value of LEGO, the copycat products is looked upon as
inferiorcvi. Some consumers will buy the copies, as they are cheaper and compatible with the LEGO blocks,
but often the bricks will give a looser fit and provide dull colors compared to LEGO blockscvii.This means
that, with the current state of the market, LEGO is able to charge a premium for their toys. This fact is also
reflected in its profit, which was 4.160 million DKK in 2011 with 18.731 million DKK in sales.
Table 3.1: Leaders OM

Operating Margin 2011
Hasbro 9,0%
LEGO 22,2%
Mattel 12,3%
Source: Own creation
37
As illustrated in table 3.1, LEGO has an operating margin of 22,21 % in 2011, whereas Mattel and Hasbro
only have 12,26% and 8,99% respectively. The difference is prominent, and further emphasizes both LEGO's
ability to charge a premium for its products, but also its success in optimizing its production process.
Competitors in the traditional toys and games market will be bound to try and penetrate LEGO's segment
further, due to the profitability and the growth it is showing. With this threat of further penetration and
competition looming, it is quite possible that LEGO’s operating margin will decrease in the future due to the
increased competition. LEGO, however, welcomes the competition as it is stated that it will keep the
company on its toescviii. And if LEGO is to keep its high operating margin with its competitors trying to steal
market shares, it is vital that the company indeed stay on its toes and compete on other areas than price.
Areas such as product features, quality, support services, delivery time and brand image will be critical for
sustaining both growth and profitability. Competing on these areas will also raise the barriers of entry and
increase value relative to substitutes.
3.4 Internal Analysis

Through this internal analysis, the goal is to find LEGO's core competences, which presents LEGO with a
competitive advantage. The previous analysis suggests that LEGO is indeed in possession of such
capabilities. The analysis' scope is to understand how these resources are utilized and how they create value
for LEGO. The VRIO framework has been chosen as the instrument to dissect LEGO. The framework asks
four questions of the resource or capability identified. If the questions to the resource or capability can all be
answered with a yes, then the resource or capability can be considered a sustainable competitive advantage
and economic performance above normal can be expected. The framework is depicted in the following table.
Table 3.2: The VRIO framework

Resource Competitive Economic
Resource Resource Resource costly exploited by implications if performance if
valuable? rare? to imitate? firm? exploited exploited
Competitive
No No disadvantage Below normal
Yes No Yes Competitive parity Normal
Temporary competitive
Yes Yes No Yes advantage Above normal
Sustained competitive
Yes Yes Yes Yes advantage Above normal
Source: Own Creation, Barney & Hesterly 2006
Due to the limitations of the thesis, not every resource or capability can be explored and the thesis will
therefore take a more general view to some of the aspects found to be the most important to LEGO's success
through the prior analysis and outlining of LEGO's situation. Firstly the tangible resources will be analyzed,
followed by the intangible resources and lastly the organizational capabilities. Each resource will be assessed
38
in regards to the VRIO framework. Some resources might overlap, and will therefore be mentioned several
times, but this is natural due to the complexity of a multinational company.
3.4.1 Tangible Resources

This group of resources include; financial resources, physical resources, technological resources and
organizational resources.
3.4.1.1 Financial
LEGO is an unlisted company, and are therefore not able to raise funds and capital through the sale of its
securities. LEGO has to borrow or use the liquidity it already has, which almost became the death of the
company early in the 2000's. Its borrowing capacity has become better, as its success has ensured financial
institutes that LEGO is safe to lend to. LEGO does have substantial capital and would be able to utilize its
financial resource to take advantage of an opportunity, further its primary owner, Kirkbi A/S has equity of 30
billion DKKcix. The substantial capital in the parent firm ensures LEGO available capital, should the need
occur. The resource is not rare in the industry as many competitors have capital to take advantage of
opportunities or can raise it at will. LEGO does however have a considerable advantage compared to the
lesser competitors and new entrants, as they are rarely backed with the kind of capital LEGO is in possession
of. Therefore the financial resource of LEGO is valuable and rare to a certain point; hence it results in
competitive parity, and competitive advantage in regards to lesser competitors.
3.4.1.2 Physical
Physical resources, which could be a competitive advantage, consist of modern plants and facilities,
favorable manufacturing locations and state-of-the-art machinery and equipment.
LEGO has very modern plants and facilities. After its failed outsourcing of production, it now has in-sourced
most of its production, as JVK realized it was a core competence of LEGO. LEGO has invested heavily in
new plants and currently has its primary production on plants in Denmark, Hungary, Czech Republic and
Mexico, with a new plant being built in China to handle future demand in the Asian market. The factories are
placed strategically to handle demand in the different regions, thereby lowering shipping costs. LEGO
continuously invests in capacity, as it begun building a new factory in Hungary 2011 to replace the one being
leased, and expanded the factories in Mexico and Czech Republic. LEGO's state-of-the-art machinery is well
documentedcx, as Flextronics completely failed to produce the same quality product at a reasonable price.
The locations of plants are valuable, LEGO has strategically moved production to low-wage countries close
to core markets. But this resource is not rare and easy imitable. The modern plants and facilities and state-of-
the-art machinery and equipment are valuable, rare, but not costly to imitate, as any competitor can buy the
same equipment. This results in a temporary competitive advantage for LEGO, since it is possible for a
competitor over a period of time to achieve the same kind of modern facilities and equipment,
39
3.4.1.3 Technological
Technological aspects are primarily trade secrets, innovative production processes, and patents, copyrights
and trademarks. LEGO's patents for the plastic brick have long expired but the bricks are still a registered
trademark. The trademark does prohibit other competitors of using the LEGO name, and therefore it is
valuable, but it is not rare as most big competitors have trademarked their companies. The brand value is
more relevant and will be analyzed later. As described earlier LEGO's innovative production process are
constantly evolving and LEGO spend much time and capital to optimize the process. The process is deemed
valuable, rare, costly to imitate and organized properly, hence the innovative production process is a
sustained competitive advantage. LEGO's expertise in the production process is a difference-maker for
LEGO, and part of the reasons for its high operating margin.
3.4.1.4 Organizational
LEGO has since its near death experience in the early 2000's had a really effective strategic planning
process. JVK, CEO, continues to try to optimize LEGO's management and its strategy for the different
markets. When he took over, he led the forging of the “Shared Vision” strategy, which was a 7 year plan in
three stages, which have previously been outlined. LEGO's ultimate purpose is to “inspire and develop
children to think creatively, reason systematically and release their potential to shape their own future –
experiencing the endless human possibility”, while its vision is to “pioneer new ways of playing, play
materials and the business models of play – leveraging globalization and digitalization. It is not just about
products, it is about realizing the human possibility.” Through these mission and vision statements, JVK
holds true to LEGO's core values, but he has also made the company more effective and judging by the
success of LEGO the last couple of years, one would argue that the plan worked, perhaps even better than
expected. Therefore it is conceivable to argue that this resource has value, it is rare and it is costly to imitate,
as it is very challenging to find a CEO who can implement such an effective strategic planning process. The
fact is further emphasized by LEGO's disarray and financial struggles until JVK took over, and implemented
a new strategic planning process. The process is organized properly and the resource therefore leads to a
sustained competitive advantage.
3.4.2Intangible resources
These resources consist of human resources, innovation and creativity resources, and reputation resources.
3.4.2.1 Human
LEGO's management and in particular JVK are very skilled. This is emphasized by their success after taking
over a dying company in 2004. Greatly skilled managers are a valuable commodity; hence this resource is
valuable and rare. To a certain degree it is costly to imitate, as the right fit between organization and manager
can be difficult to find. Large companies often hire high-profile CEO's, who turn out to be a flop in the
40
circumstances they are thrown into. Therefore the managerial skills of LEGO are deemed to be a competitive
advantage, since for the moment the fit is perfect.
LEGO highly prioritize the continued development of the skills of LEGO’s employeescxi. In the Progress
Report 2011, LEGO directly credits its steep growth to the skills of its employees. This is generally wise, as
it encourages the employees to work harder and more efficiently. Lego has had to increase its workforce
considerably the last few years, as LEGO had 9374 employees in 2011 compared to 7058 in 2009. The
LEGO employees do have considerable skill, and LEGO continue to invest in its employees, honing their
skills further. The employees are however not skilled to the point of being rare compared to competitors
employees. Therefore the employees are only valuable, leading to competitive parity.
3.4.2.2 Innovation and Creativity

Each year, 60 % of LEGO's sales are from new productscxii, thus there is a high demand for innovation
capacity. Several of the new product lines and systems are developed directly for education purposes,
emphasizing the requirement for a high degree of technical and scientific skills, for LEGO to be able to
develop new these new products. To achieve prowess in the area LEGO introduced a new strategic
innovation system after 2006cxiii.
The new strategically coordinated innovation system is credited to be central to the turnaround LEGO has
hadcxiv. It is led by a cross-functional team: the Executive Innovation Governance Group. The innovation
view is not just products, but more of a broad view incorporating pricing plans, community building,
business processes and channels to markets, as these all have the ability to be powerful business drivercxv.
LEGO has chosen to divide responsibility for innovation across four groups, Functional groups, Concept
Lab, Product and Marketing Development and Communication, Education and Direct. The different groups’
responsibilities have been outlined earlier, generally LEGO expects different degrees of innovation from
each and each group handles different areas of LEGO's business at different times. Since JVK became CEO,
LEGO has put a high emphasis on the need for innovative capacity. This resource has become very valuable
and rare. It is costly, tough and challenging to imitate, though not impossible. LEGO has effectively
organized it, and the resource is therefore considered a competitive advantage, though one competitor over
time can achieve given the right conditions.
3.4.2.3 Reputation
LEGO's brand name is valuable commodity to the company. It represents the expectations of customers and
consumers to its products and services. The expectation of quality quickly became synonymous with the
LEGO brand, as producing a quality product was very important to OKK in 1932cxvi. Since then LEGO has
continually held it as a core value.
41
LEGO has its own set of brand values, but more importantly is the customers and consumers view of the
company brand. Historically consumers have regarded LEGO's bricks and systems of play highlycxvii, both in
the aspect of quality, but also in the aspect of the products’ ability to improve children's skills. The LEGO
bricks and different play systems are known to increase creativity, mathematical skillscxviii, and even help
autistic children enhance communication skillscxix. This creates a really strong base for the brand, and LEGO
has increased the brand's value through continuously branding with its specific set of values, see appendix 1.
The LEGO brand ranked 10th among all brands in the world in 2012 according to a survey performed by the
Reputation Institutecxx, who surveys more than 100.000 participants.
Table 3.3: World’s strongest brands

Rank Company
1 BMW
2 Sony
3 The Walt Disney Company
4 Daimler (Mercedes-Benz)
5 Apple
6 Google
7 Microsoft
8 Volkswagen
9 Canon
10 LEGO Group
Source: Own creation, Reputation Institute 2012
The rank, depicted in table 3.3, emphasizes how strong the brand value is for LEGO, as the companies in
front of it all are larger Multinational Corporations with much higher revenue, which allows more capital to
be invested in their brand. Notably no other traditional toy-maker is in the top 100, though the video game
manufacturer Nintendo is 32nd. The LEGO brand is valuable, rare and very difficult and costly to imitate.
LEGO has since its near-death experience been able, under JVK's leadership, to organize this valuable
resource properly, hence creating a sustainable competitive advantage.
As mentioned LEGO's reputation with retailers has changed drastically since JVK forced the company to
better the conditions for them, thereby improving its relationship drastically. This resource is valuable, but it
is not rare and leads to competitive parity, as most competitors know it is valuable to have a good
relationship with retailers such as Toys R' Us', Wal-mart etc.
3.4.3 Organizational Capabilities

This part considers a company's capacity to combine tangible and intangible resources through firm
processes to attain a desired end. Further a company's competences or the skills it employs to transfer inputs
to outputs are consideredcxxi. The thesis has throughout the VRIO analysis praised LEGO for its effective
42
processes, both production and innovation wise. It is found apparent that since JVK took over as CEO,
LEGO's processes have been optimized efficiently. Some areas, such as customer service, in regards to
consumers, were already in place, but JVK modified the innovation process, the productions process, after a
failed attempt to outsource it, and in general LEGO's whole complex operating modelcxxii. Therefore LEGO's
organizational capabilities are valuable and rare, they are difficult and costly to imitate and organized
properly. This leads to a competitive advantage for LEGO.
With the two top toy makers in the world entering LEGO's segment of the market to a degree, due to high
profitability and growth, it will be interesting to see how the situation will be handled by LEGO, and how
LEGO will manage under these new circumstances.
Table 3.4 : VRIO Framework summarization

Valuabl Costly to Exploite Economic
Resource e? Rare? imitate? d? Competitive implication implication
To an
Financial Yes Yes Competitive parity Normal
extent
Physical Yes Yes No Yes Competitive advantage Above normal
Technological Yes Yes Yes Yes Above normal
advantage
Organizational Yes Yes Yes Yes Above normal
advantage
Human Yes No Yes Competitive parity Normal
Innovation and
Yes Yes To an extent Yes Competitive advantage above normal
creativity
Reputation Yes Yes Yes Yes Above normal
advantage
Organizational Sustained competitive

Yes Yes Yes Yes Above normal
Capabilities advantage
As depicted in table 3.4 LEGO has several considerable competitive advantages, which explains how the
outperformed its competitors for the last 5 years.
3.5 SWOT
To complete the strategic analysis, this chapter will use the information found in the previous analysis to
identify LEGO’s strengths, weaknesses, opportunities and threats in a SWOT-analysiscxxiii.
43
Figure 3.5
Strengths Weaknesses
•Brand •Premium prices product
•Education and play value of product •Chiefly single category focus
•Organizational capabilities •Potential outsourcing near impossible
•Strong management •High costs
•Quality product •Dependent on external licensing rights
•Ability to penetrate the girl segment
•Market leader in construction toys
SWOT LEGO
Opportunities Threats
•Emerging markets are growing •Competition
•New product categories •Age compression
•IPO •Shorter product lifecycle
•Legislation
3.5.1 Strengths:
LEGO’s brand is an important strength to the company. The brand is well known and respected by many
people throughout the world. It is synonymous with quality and a unique playing system. The educational
and play value of the product ensures its popularity with both parents and children. It has also made LEGO
present within the educational system in many countries, where LEGO’s product is used in educationcxxiv.
LEGO underwent a near-death experience in the early 2000’s, but has been able to turn it around since.
LEGO already had the brand value, but were not capable of utilizing it the right way. The turnaround was
spearheaded by JVK and the changes he brought along. This signals a strong management, which has proven
to be a real strength. JVK has been able to utilize both brand and the organizational capabilities, turning them
into competitive advantages. The strength in the organizational capabilities lies in its operating model, which
has been greatly optimized since 2004. The new innovative approaches, which have been described, are
keeping LEGO on cutting edge product-wise, operating wise and in general on all levels of the company. It
is able to use innovative approaches without moving away from its core values. The success of its operating
model is emphasized by the success in the girl segment through the LEGO Friends series, LEGO has
44
previously failed in its attempts to reach out to girls in general, but has now achieved what it could not in the
past.
LEGO is the market leader in construction toys on most major markets, providing the company with certain
advantages. It is synonymous with construction toys, its products are of the highest quality and it has a great
level of knowledge in regards to both the construction toys market and producing high quality toys.
3.5.2 Weaknesses
LEGO’s products are highly priced. This is primarily due to the quality of the product, but LEGO has an
operating margin north of 20%, which indicates LEGO is able to charge premium prices for its products as
no other products are comparable substitutes. The high price could however be a weakness in the long run as
new competitors could enter the market with cheaper products. The threat of new competitors could press
LEGO to lower its prices, and as LEGO is chiefly focused on this single category of toys, it could potentially
hurt its profits significantly.
The failure with Flextronics shows that outsourcing, without compromising on quality, is near impossible as
it is not possible for others to imitate the know-how LEGO has of producing its products. In the long run this
could prove a weakness, as competitors are able to obtain lower costs through outsourcing. Therefore LEGO
could potentially have considerably higher costs than competitors looking forward.
The whole industry is very dependent on license rights, as children want toys from the themed worlds they
know from television, computer games etc. This is also the case with LEGO, as much of its revenue
originates from licensed products, and this dependence puts LEGO side by side with all its competitors
scrambling for the next contract for licensing rights.
3.5.3 Opportunities
The emerging markets represent opportunity for expansion. LEGO has already started expanding in Eastern
Europecxxv and Asia, but there is opportunity for expanding even more and taking advantage of these growing
markets.
As LEGO has a predominant single category focus, an opportunity is to expand its category focus. Utilizing
its efficient operating model to enter other segments of the toys and games industry could be possible. The
problem is that when they were in serious problems, a part of it was too much diversification, but it is an
opportunity nonetheless.
LEGO could launch an initial public offering. This could increase the value of the company, increase its
attractiveness for prospective employees and also be beneficial for tax purposescxxvi. It is found unlikely that
LEGO would do this within the near future as the family behind LEGO is content with current
circumstances.
45
3.5.4 Threats
Competitors want to penetrate LEGO’s construction toys segment, and present a major threat to LEGO, as
evidenced by the top two companies’ in the toys and games industry entrance in the market.
Further demographic conditions, such as age compression, is a threat as the compression point to a lower
target group for toymakers. At the same time, products in the toy industry have still shorter lifecycles, as fad
toys continue to rise and fall, resulting in a potentially unstable environment for competitors.
Lastly legislation is a threat. Safety is the foremost aspect to parents, and therefore also to politicians,
ensuing continued focus on possible side effects from the chemicals in toys. If new studies were to show that
any chemicals in toys are dangerous, it could result in toys having to be called back and a stalled production,
while a new chemical is found to replace the dangerous one.
4. Financial Analysis
The scope of this chapter is to conduct a comprehensive analysis of LEGO’s historical financial
performance, hereby providing an overview of the financial situation of the company. The analysis uses
numbers from the public annual reports published by LEGO from 2006 to 2011, as such a period allows for
analyzing a business cycle. Reformulated financial statements will be presented and the various value drivers
will be identified.
The years prior to 2006 were in the aftermath the near-death experience, hence the financial performance in
these two years will not be comparable to future performance.
4.1 Peer Group

An analysis of LEGO’s peers’ performance is instrumental to evaluate LEGO’s true performance. Analyzing
their performance, enables a comparison with LEGO’s performance, providing information on whether the
success can be attributed to the industry or LEGO themselves.
Two companies have been identified as peers, Mattel and Hasbro. These two companies are the biggest in
the industry, and are LEGO’s primary competitors in its core markets. Both companies have higher revenues
than LEGO, but LEGO has been gaining ground on them through the last several years, making an in-depth
benchmarking both interesting and very suitable. Suitable peers should have equal or close to sales
growthcxxvii, but no such peers were found in the toy industry, which were also an industry leader. It is
possible to use peers from different industries, but this thesis found than an analysis of Mattel and Hasbro,
and a subsequent comparison would bring value to the achieved information level, enabling a more profound
and precise valuation.
46
4.2 Applied Accounting Policies
LEGO reports its financial statement in accordance with the International Financial Reporting Standards
(IFRS)cxxviii, as is endorsed by the legislation of the EU. LEGO did not change its accounting policies to the
IFRS standards until 2007, hence prior years’ financials are difficult to compare with the new financials. The
2007 annual report, however, contains the revised financial numbers for 2006cxxix, which therefore makes it
applicable for analysis. The numbers for 2006 is therefore taken from the annual report of 2007.
The 2009 annual report has implemented a few new or changed standards of accounting, but these are of
such a character that they are not deemed noteworthy for the financial analysis.
Pricewaterhouse Coopers has audited the annual reports and has found nothing to report, as it states that the
Consolidated Financial Statements for the LEGO Group give a true and fair view of the Group’s financial
position and of the results in the given yearcxxx. Therefore it can be assumed that IFRS standards are met and
that the annual reports provide a truthful image of the current financial situation of LEGO.
Both Hasbro and Mattel report in accordance with the GAAP accounting principles made by the FASB,
which are the generally used principles for listed American companies. The primary difference between
GAAP and IFRS is that IFRS is a principle based standard, whereas GAAP is a rules based standardcxxxi. A
few differences are the treatment of intangible assets, inventory costs and write downs. Their accounting
principles therefore differ from LEGO’s, but the thesis assumes that it will not have a significant impact on
the benchmark analysis.
4.3 Reformulation the Financial Statements

The financial statements have to be reformulated in order to be applicable for the profitability analysis. The
reformulation will be based upon the NOPAT and Invested capital methodcxxxii. The goal is to separate
operating activities and financial activities, hereby showcasing the true value derived from operational
activities.
4.3.1 Statement of shareholders’ Equity

Reformulation of the equity statement is needed to distinguish creation of value from the distribution of
value to shareholders. The reformulation will identify dirty-surplus items and the total comprehensive
income. Further the minority interests will be subtracted as these represent parts of consolidated subsidiaries
not controlled by LEGO. For LEGO the primary items impacting the total comprehensive income is cash
flow hedges, tax on the hedges and currency translation differencescxxxiii. LEGO’s and its peer groups’
reformulated statements of shareholders’ equity can be found in appendix 2.
47
4.3.2Balance Sheet
The reformulation of the balance sheet will classify the items in operating assets and liabilities, and financial
assets and liabilities.
LEGO employs financial leasing and the costs of these should be classified as financial liabilities. In the
annual reports the costs are under the items “Other short-term debt” and “Other long-term debt”. These have
been cleaned from financial leasing, and will be classified as operating liabilities.
The operating liquidity is not stated in the annual reports, and has been estimated to 2% of the sales and
classified as an operating assetcxxxiv. The remaining liquidity, “excess cash” is classified as a financial asset.
All 3 companies employ operating leases, which the next section will elaborate on how to adjust for.
LEGO’s and its peer groups’ reformulated balance sheets can be found in appendix 3.
4.3.2.1Capitalization of Operating Leases

Lego and its peer group all employ operating leases, which is a form of financing, enabling them to keep
assets and their corresponding debt off the balance sheet, known as off-balance financingcxxxv.Only the
periodic rental expense is listed on the statements, the income statement, which results in an undervaluing of
the company’s operating assets and financial debt. Companies often do this to keep their debt to equity and
leverage ratios low, and it will create biased numbers. Therefore it is necessary to adjust by estimating the
asset value, as the present values of the operating leases are not listed by any of the companies.
The adjustment is the following: the estimated value of the operating leases, capitalization of operating
leases, will be placed as an operating asset and a corresponding adjustment will be made in long term debt.
Further an adjustment will be made to the income statement as implicit interest in rental expense will be
removedcxxxvi. The method for estimating the value will be based upon the periodic rental expenses with the
following equationcxxxvii:
To apply the formula the rd and Asset life must be determined. As all competitors state, in their annual
reports, that their operating leases consist of a mix of plant, equipment and property it can be assumed that
the asset life for all three companies is 10,9 years, as in research of over 7000 firms over 20 years, this was
the median life for assetscxxxviii.
The rd, which is the operating lease cost, can be estimated by applying an AA-rated corporate bond yield, and
not by using the company’s overall cost of debt. This evades the problem of circular references as the
capitalization of operating leases will impact the Net Borrowing Cost (NBC) of the companies. The
48
estimation is possible due to the fact that the operating lease is secured by the underlying asset, meaning it is
less risky than the company’s unsecured debt. The UK Corporate bond AA’s and US Aaa Corporate bond’s
yields will be used and the arithmetic average applied as the rd.
Table 4.1: Cost of Operating Lease 2007 2008 2009 2010 2011 Average
UK Corporate Bond AA 5,90% 7,20% 5,80% 5,60% 4,70% 5,80%
US Aaa Corporate Bond 5,60% 5,60% 5,30% 4,90% 4,60% 5,20%
Average 5,70% 6,40% 5,50% 5,30% 4,70% 5,50%
Source: Own creation, Yahoo Finance
As all necessary components have been found to calculate the asset value for capitalization of operating
leases, the values are calculated in table 4.2 below.
2006
2007
2008
2009
2010
2011
Table 4.2: Cost of COL Company
Cost of operating expenses All 5,70% 6,40% 5,50% 5,30% 4,70% 5,50%
Asset life All 10,9 10,9 10,9 10,9 10,9 10,9
LEGO, DKK 143 131 194 188 248 285
Operating lease expense Mattel, USD 86,9 93 105,3 121,9 117,8 113,3
Hasbro, USD 35,6 36,9 43,6 43,6 41,9 47,4
LEGO, DKK 878,4 1246,4 1277,7 1717,5 2057,1 1939,1
Asset value Mattel, USD 623,6 676,5 828,4 815,8 817,8 770,9
Hasbro, USD 247,4 280,3 296,1 290,3 342,4 322,8
LEGO, DKK - 56,1 69,1 67,3 80,4 113,6
Imputed interest expense Mattel, USD - 39,8 37,5 43,6 38,2 45,2
Hasbro, USD - 15,8 15,5 15,6 13,6 18,9
LEGO, DKK - 80,6 114,4 117,2 157,6 188,7
Depreciation Mattel, USD - 57,2 62,1 76 74,8 75
Hasbro, USD - 22,7 25,7 27,2 26,6 31,4
4.3.3Income Statement
The reformulation of the Income Statement will classify items in order to calculate NOPAT, net operating
profit after taxes. Depreciation and amortization are allocated into different parts of income statement and
must be separated. Taxes are listed as a total and have to be separated into taxes regarding operation and
taxes regarding financials. The tax shield has been removed from the original tax item, hereby showcasing
the taxes related to operations. LEGO’s and its peer groups’ reformulated income statements can be found in
appendix 4.
4.4Profitability Analysis
The following section will focus on obtaining the true performance of LEGO from its financial statements.
The underlying factors contributing to Return on Equity (ROE) will be examined. ROE measures the
49
profitability of shareholders’ investments and is affected by both the operating and financial activities of the
company. The DuPont model for decomposition of the main drivers will be the framework applied.
Figure 4.1:
Return on Equity
Return from Return from

operating financial
activities activities
Financial Operating
Return on invested capital
leverage spread
NOPAT/Invested capital
NIBD/EQ ROIC-r
Turnover rate
Profit margin
Revenue/Invested
Nopat/revenue
capital
Source: Own creation, Elling & Sørensen
As illustrated in figure 4.1, the left side of the figure relates to the core operations of LEGO, expressed
through the return on invested capital, while the right side relates to the financial activities, where the
financial leverage and operating spread expresses the financial gearing of the company.
4.4.1 Return on Equity

There are several ways of deriving ROE, the most common definition iscxxxix:
The denominator is the average starting and ending book value for the year, as this allows for a more true
measure of performance. By calculating the average value for the year, the development in the year is taken
into account. In the DuPont model, however ROE is calculated by using the underlying drivers:
As LEGO lists “Minority Interest” on the balance sheet, a correction has to be made to find the correct
ROEcxl:
50
Figure 4.2: ROE
100% 92%
90% 83%
80% 72% 73%
67%
70%
60% LEGO
50%
Mattel
40%
28% 29% Hasbro
30% 25%24% 22% 23%25% 25% 25%
17%
20%
10%
0%
2007 2008 2009 2010 2011
Figure 4.2 displays the yearly ROE for the last 5 years. As averages are needed, 2006 could not be calculated
using the above formula due to the change in accounting policies in 2007, hence the year has been excluded.
It’s apparent from the numbers that LEGO has been extremely successful during the analyzed period. Further
it is clear LEGO has been outperforming its competitors in terms of return on equity. The difference is
striking and emphasizes the reasoning behind Mattel and Hasbro entering LEGO’s segment.
In the subsequent section the two drivers of the ROE will be analyzed, return from financial activities and
return from operating activities.
4.4.2 Return from Financing Activities

The return from financing activities consists of two drivers, Financial Leverage (FLEV) and Operating
Spread (Spread)cxli.
4.4.2.1 Financial Leverage

Financial leverage is the ratio showing to which degree a company’s invested capital is financed by
borrowing through Net Interest Bearing Debt (NIBD) or by equity. As LEGO has minority interest,
51
minorities will have to be added to the equation. Mattel and Hasbro do not have minority interests and their
FLEV will be computed by the regular equation. The FLEV is computed with the following equationcxlii:
Figure 4.3: FLEV

250%
203%
200%
150% 129% LEGO

104%
Mattel
100% 84% 83%
65% Hasbro
53%47% 55%
45% 42%40%
50% 28%28% 31%
0%
2007 2008 2009 2010 2011
As illustrated in figure 4.3, LEGO had a very high financial leverage compared to the peer group in 2007 and
2008. The high financial leverage primarily originated from LEGO’s loans during its turnaround. It has
quickly been able to pay them off and the financial leverage was down to 42% in 2011, close to Mattel’s and
significantly lower than Hasbro’s. Mattel’s FLEV has varied during the period, settling at 40% in 2011,
while Hasbro’s FLEV has been increasing every year in the period ending at 104% in 2011. LEGO and
Mattel have equity greater than their NIBD, evidenced by their ratio being lower than 1. Capitalization of
Operating Leases has a significant impact on the financial leverage as the asset value impacts the NIBD.
4.4.2.2 Operating Spread

Operating spread is the difference between Return on Invested Capital (ROIC) and Net Borrowing Cost
(NBC)cxliii:
52
Figure 4.4 illustrate the companies’ operating spread s. The figure shows significant variation on LEGO’s
spread, as it increased from 23% in 2007 to 55% in 2010 and to 41% in 2011. As LEGO has been able to
reduce its cost of debt, it has simultaneously increased its ROIC, resulting in the high spread. Both Mattel
and Hasbro have more stable spreads with values ranging from 7%-15% and 9%-12% respectively.
Figure 4.4: SPREAD

60% 55%
50%
43% 41%
40%
LEGO
30% 27%
23% Mattel
20% 15% Hasbro
13% 13%
9% 10% 10%12% 11% 10%
10% 7%
0%
2007 2008 2009 2010 2011
NBC is one the underlying drivers for the spread, and is computed through the following equationcxliv:
2007
2008
2009
2010
Table 4.3 : Net Borrowing Cost 2011

LEGO 3% 10% 3% 6% 8%
Mattel 9% 6% 9% 9% 9%
Hasbro 12% 8% 6% 5% 6%
As table 4.3 displays, there is variation on the cost of debt for the companies and the values show no
correlation with general interest levels.
4.4.3 ROIC
The return from operating activities is expressed through the term, return on invested capitalcxlv:
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Neither NOPAT nor average IC includes any income from financing activities and are therefore independent
of capital structure.
Figure 4.5: ROIC

70%
61%
60%
49%
50% 46%
40% 37% LEGO
30% Mattel
26%
22%22% 23% 23%
18%17% Hasbro
20% 18% 16%
13% 15%
10%
0%
2007 2008 2009 2010 2011
Figure 4.5 displays the development of ROIC for the three competitors. If figure 4.5 is compared with figure
4.2, the strong relationship between ROE and ROIC becomes clear. The ROIC clearly shows that LEGO has
been outperforming its competitors over the period as its ROIC continually increased until 2010 before
declining to 49% in 2011. Mattel’s ROIC dropped from 22% to13% in 2008, but has since increased to 23%
in both 2010 and 2011. The drop in 2008 can most likely be contributed to the financial crisis. Hasbro is the
underperformer of the group in regards to ROIC, as it has had a lower ROIC in all years except 2008. Hasbro
has experienced a steadily decreasing ROIC in the period from 22% in 2007 15% in 2011.
To further understand what drives the ROIC, the underlying drivers of ROIC will be examined.
4.4.3.1 Profit Margin and Asset Turnover

The asset turnover rate shows the sales revenue per DKK/dollar of invested capital, hence illustrating a
company’s ability to convert invested capital to salescxlvi. The profit margin exemplifies how profitable each
DKK/dollar of sales is. For LEGO restructuring costs have been included in NOPAT, as a company of
LEGO’s size with its current growth can expect to have to restructure every 5 to 7 years.
Table 4.4 shows how LEGO has been able to increase its profit margin to 26% in 2010 from 14% in 2007,
before experiencing a decrease of 3% to 23% in 2011 Mattel and Hasbro have had significantly lower profit
margin, as Mattel and Hasbro went from 11% and 10% to 14% and 11% respectively. This emphasizes the
54
success LEGO has had, particularly compared to its competitors since its turnaround. Further it is a
significant profit margin, no matter the industry, and it indicates LEGO’s prowess to do business in a
successful way.
2007
2008
2009
2010
2011
Table 4.4: Asset turnover and profit margin
LEGO 1,84 2,21 2,37 2,36 2,11

Asset Turnover Mattel 1,97 1,74 1,61 1,74 1,7
Hasbro 2,06 1,97 1,65 1,36 1,38
LEGO 14% 17% 20% 26% 23%
Profit Margin Mattel 11% 8% 11% 13% 14%
Hasbro 10% 9% 11% 12% 11%
As displayed in table 4.4, LEGO had the lowest turnover rate of the three at the start of the period, but from
2008 and onward LEGO’s turnover rate has been higher than its peers. Mattel’s and Hasbro’s turnover rate
has been declining almost every year, which is one of explanations for Hasbro’s declining ROIC, as its profit
margin has been relatively stable throughout the period.
4.5 Risk analysis

The following section will explore LEGO’s risk profile. The risk profile of a company is important to owners
and investors as a higher degree of uncertainty regarding future cash flows will result in higher demands for
expected returns. The risk profile will allow for an understanding of the risks associated with LEGO, and be
of note in the final valuation. The risk analysis will be in two parts, first the operational risk and secondly the
financial risk.
4.5.1 Operating Risk

The operational risk includes three components; external risk, strategic risk and operational risk. As external
risk and strategic risk have already been covered in chapter 3, they will not be covered here. The potential
volatility in the ROIC results in operating riskcxlvii. This volatility in the ROIC is driven by the underlying
drivers of ROIC, profit margin and asset turnover. Further the uncertainty concerning the company’s
investment opportunities are a risk, the growth risk.
Profit margin risk is the risk of profit margins changing for a given level of sales and therefore driven by the
risk of expense (sales costs, administration costs, labor expenses etc.). Naturally due to its success, LEGO’s
costs have risen along with its sales, and LEGO has consequently had significant changes in its profit margin
as it increased through 2010 before declining a bit 2011. The increased profit margins indicate a low profit
margin risk as lower sales would not put LEGO in an unmanageable situation.
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The asset turnover risk is deemed low for LEGO. LEGO has a wide base of loyal customers, its turnover rate
is highcxlviii and its products do not really become outdated. Its asset turnover is higher than its competitors
and it kept increasing throughout the financial crisis, indicating flexible assets.
4.5.2 Financial Risk

The financial risk comprise of financial leverage and variation in operating spread, as NBC is component of
the formula for operating spread. Hence, the two components examined will be FLEV and NBC.
LEGO’s FLEV were significantly decreased over the period. In 2010 the FLEV was down to 11,8% and
10,2% in 2011. The FLEV was high during the start of the period, due to the restructuring costs incurred in
the aftermath of the near-death experience. LEGO has, however, due to its great results been able to pay off
the loans, reducing its FLEV significantly. This greatly reduces LEGO’s financial risk, as a negative change
in the operating spread would be insignificant at its current low FLEV. LEGO has therefore, after it paid off
the various loans, employed equity financing.
The interest rate risk for LEGO is considered insignificant, as changes would have minimal impact on
LEGO’s resultscxlix.
4.6 Part Conclusion

The scope of the chapter was to conduct a comprehensive analysis of LEGO’s historical performance,
providing an overview of the financial situation in the company.
Mattel and Hasbro were chosen as peers, as they were found to be the closest match. No competitor matches
LEGO’s growth, while also being of a significant size.
The analyzed period showed an increasing ROE from 2007 to 2010, before a drop down to 67% in 2011,
which showed that LEGO significantly outperformed its competitors over the period.
The underlying drivers of the ROE were then explored, return from financing and return from operating
activities, whose subcomponents were then analyzed. The financial leverage showed a decreasing trend as
LEGO’s success has resulted in a mainly equity financed operating model, while the operating spread
increased from 2007 to 2011 before dropping to 41% in 2011. The ROIC development is similar to the ROE
and operating spread, which is natural because ROIC is a deciding component of the other two, with increase
in the level from 2007 to 2010 before a drop to 49% in 2011. The ROIC level is still notably better than
LEGO’s peers. The drivers of ROIC, profit margin and asset turnover, showed an asset turnover for LEGO
which were better than its peers and a profit margin considerably better than its peers.
The analysis of LEGO’s risk showed a low operating risk, as well as a low financial risk. This can be
benefited to its success, operating model and brand.
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5. Budgeting and Forecasting
This chapter will contain budgeting and forecasting, estimating LEGO’s future financial performance, which
is imperative to the subsequent valuation. The forecasting is based upon the findings in previous chapters,
the strategic and financial analysis, as these have explored the context in which LEGO operates, as well as
LEGO and its financials.
5.1 Forecast Period

This section will explore the length of the forecast period. Several aspects are of importance when
determining the length of the forecast period. The explicit forecast period should be long enough that the
company is able to reach a steady state, in which the company’s growth will fall to a constant long term
growth rate. When the steady state is reached, the profit margin must also be held at a constant, ensuring the
costs growing correspondingly with sales. Lastly the turnover rate and the FLEV must remain constantcl.
When the steady state is in effect the free cash flow will grow at a constant rate until infinity. The value of
this period, is considered a growth perpetuity and called the Terminal Value:
The forecast period has been set to ten years, as it is assumed that in this period of time LEGO will reach a
form of steady state. The assumption of LEGO reaching a steady state is filled with a degree of uncertainty.
But a longer forecast period would result in a very high degree of uncertainty as forecasting individual items
on the statements in the far future is very difficult. Within the next ten years it is realistic that LEGO has
reached a stalemate in the battle with Mattel and Hasbro for the constructions toys segment, that the North
American construction toys market have become saturated like the Western European and that LEGO has
achieved a foothold in emerging markets.
5.2 Income Statement Forecast

The income statement forecast will project future sales growth, cost, tax rate, unusual items and net operating
profit after taxes (NOPAT). The complete forecasted income statement as ratio to sales can be found in
appendix 7.
5.2.1 Sales Growth

Terminal
Table 5.1
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
2020E
2021E
Sales growth 23% 20% 17% 16% 14% 12% 10% 10% 9% 7% 4%
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As depicted in table 5.1, sales growth will continue at a high level, but eventually competition and reaching
caps on different markets will result in lesser sales growth. The American market in particular can be
expected to reach a cap at a certain point resulting in sales growth more similar to the UK and Germany. The
terminal growth rate is set at 3%, which is high. The growth rate will be explored later in the chapter.
Contributing to the highly projected sales are expectations for the Asian and the Russian market, in which
this thesis project LEGO to achieve a high level of success.
5.2.2 Costs
Terminal
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
2020E
2021E
Table 5.2: Cost
Production cost 28% 28% 29% 29% 29% 30% 30% 31% 31% 32% 34%
Sales and distribution 27% 27% 28% 28% 29% 29% 30% 30% 30% 31% 32%
Administration 6% 6% 6% 6% 6% 6% 6% 6% 6% 6% 7%
Other 6% 6% 6% 6% 6% 6% 7% 7% 7% 7% 7,50%
Depreciation 3% 3,10% 3,10% 3,20% 3,20% 3,30% 3,30% 3,40% 3,40% 3,50% 3,50%
Total cost of sales 69% 70% 71% 72% 73% 74% 75% 77% 78% 79% 84%
Profit margin 31% 30% 29% 28% 27% 26% 25% 23% 22% 21% 16%
Table 5.2 displays all costs future costs as a percentage of sales. The starting level for production costs has
been calculated from a 4-year historical average of previous cost/sales ratio, this corresponds with a small
increase in the ratio. Sales and distribution, administration and other have however, due to the historical
trend and development been projected to decrease a little from 2011 to 2012E. From 2012E these costs are
however also projected to increase gradually every year, due to the growth of the organization, as LEGO will
have to expand and hire new employees etc. Further, according to theory, competition hurts profitabilitycli,
and the increased competition in LEGO’s segment will make it harder to maintain current ratios Therefore
the ratios, for all of the 4 items from 2012E and beyond, have been projected to increase by 1,5% every year
until 2021E. LEGO’s peers, which are both considered highly successful companies, have both significantly
higher costs, which makes it probable that LEGO’s costs will gradually rise, nearing the costs of the peers.
Mattel’s and Hasbro’s production costs are both around and 40%. Due to the excellent operating model
LEGO employs and its strong brand, this thesis does however believe LEGO will be able to keep its cost
significantly below that of its peers, thus the 34% terminal production cost-to-sales ratio. Depreciation is
expected to increase only slightly as well, resulting in a terminal level of 3,5%.
5.2.3 Tax Rate

The future tax rate will be set to the Danish corporate tax, 25%. As the tax shield is computed from the
financial items, which are very difficult to project accurately, it will not be taken into account for the
58
projections. A future lower corporate tax rate is possible, but it is quite difficult to gauge whether or not the
politicians will lower it, thus it is reasonable to use the current tax rate.
5.2.4 Unusual Items

Unusual items are projected to zero, as it is impossible to project such itemsclii, and are therefore not a part of
the projected income statement. It is possible LEGO would have to restructure its organization at some point
with the growth it is having, but the costs of such are difficult to project. Further it would not be of
significance to the valuation as LEGO’s profits are very high.
5.2.5 NOPAT
After forecasting the items in the income statement, excluding financial items, the forecasted NOPAT can be
computed. The table below displays how NOPAT is projected to evolve in the period.
Figure 5.1: NOPAT and Profit margin

12000 35%
10000 30%
25%
Millions DKK
8000
20%
6000 NOPAT
15%
4000 Profit Margin
10%
2000 5%
0 0%
Projected year
Figure 5.1 plainly illustrates a strong development for LEGO over the period, as NOPAT increase every year
in the period, but is projected to be a little lower for the terminal period. The strong development is driven by
the forecasted sales growth, as the sales growth does is in double digits until 2020. The costs will eventually
drive down the profit margin, impacting the NOPAT significantly for the terminal period.
5.3 Balance Sheet Forecast

The primary goal of this section is to gauge LEGO’s future invested capital. Thus, several items on the
balance sheet must be forecasted. The degree of difficulty to project individual balance sheet items is
considered highcliii, therefore a more overall approach will be taken as many of the items in Net Working
Capital (NWC) and Net Non-Current Operating Assets (NNCOA) will be projected based on historical
59
numbers. Together these two will amount to the invested capital, as NWC is calculated by subtracting the
operating liabilities from the operating assets, while NNCOA is calculated by subtracting the non-current
liabilities from the non-current operating assets s. The balance sheet items are projected as a percentage of
salescliv. The complete balance sheet forecast as a ratio to sales can be found in appendix 8.
5.3.1 Net Working Capital Forecast

LEGO’s operating assets have primarily been driven by the items, inventories and receivables, as they are
the most significant items. No items show a particular trend, therefore all items have been estimated from a
historical 3-year average, as LEGO is expected to continue its growth, it is also expected LEGO can maintain
its balance sheet items to sales ratio.
Terminal
Table 5.3: Percent of sales
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
2020E
2021E
TOCA 0,369 0,369 0,369 0,369 0,369 0,369 0,369 0,369 0,369 0,369 0,369
TOCL 0,161 0,161 0,161 0,161 0,161 0,161 0,161 0,161 0,161 0,161 0,161
NWC 0,208 0,208 0,208 0,208 0,208 0,208 0,208 0,208 0,208 0,208 0,208
The forecasted ratio for total operating current assets (TOCA) to sales has been estimated to 0,369, while the
total operating current liabilities (TOCL) has been estimated to 0,161, resulting in a NWC ratio of 20,80%,
as depicted in table 5.3. The ratio seems probable and realistic in relation to previous analysis. Forecasting
specific up and downturns in the items each year would be guesswork and therefore an overall expectation of
a similar level is most realistic for the purposes of this thesis.
5.3.2 Net Non-Current Operating Assets forecast

LEGO’s non-current operating assets primarily consist of capitalized operating leases, land, buildings and
installations and plant and machinery. Fixed assets under construction has, however, been increasing
steadily from 2006 to 2011, and as it is assumed LEGO needs to continually invest in fixed assets to handle
future demand, this singular item is projected to continue to grow with 0,30 percentage points until the 2021,
with a terminal value of 0,057 of Sales. The rest of the items, including the items in non-current operating
liabilities, are estimated based upon a 3 year historical average.
Terminal
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
2020E
2021E
Table 5.4: Percent of Sales
Total Non-Current Operating Assets 0,317 0,32 0,323 0,326 0,329 0,332 0,335 0,338 0,341 0,344 0,344
Total Non-Current Operating Liabilities 0,014 0,014 0,014 0,014 0,014 0,014 0,014 0,014 0,014 0,014 0,014
60
Net Non-Current Operating Assets 0,303 0,306 0,309 0,312 0,315 0,318 0,321 0,324 0,327 0,33 0,33
As table 5.4 illustrates, NNCOA increases throughout the period, before settling at 0,33. The invested capital
can now be computed.
Terminal
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
2020E
2021E
Table 5.5: Percent of Sales
Net Working Capital 0,208 0,208 0,208 0,208 0,208 0,208 0,208 0,208 0,208 0,208 0,208
Net Non-Current Operating Assets 0,303 0,306 0,309 0,312 0,315 0,318 0,321 0,324 0,327 0,33 0,33
Invested Capital 0,511 0,514 0,517 0,52 0,523 0,526 0,529 0,532 0,535 0,538 0,538
Source: Own Creation
Table 5.5 illustrates the development of the invested capital. The invested capital increases from 51,1% of
sales in 2012 to 53,8% of sales in 2021, which also is the terminal value.
5.3.3 Forecasted Return on Invested Capital

The forecasted ROIC is computed from the previous findings of NOPAT and Invested Capital:
Figure 5.2: ROIC

45%
40%
35%
30%
25%
20%
15% LEGO
10%
5%
0%
The development in ROIC, depicted in figure 5.2, reflects previous analysis, as it is expected that LEGO will
face more competition in its segment and potential caps in certain markets. These factors will drive down
LEGO’s ROIC, but the level of ROIC will however continue to be strong.
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5.4Forecasted Free Cash Flow
Through the projected values and ratios in this chapter we are able to project future free cash flow to firm,
the calculations can be found in appendix 9.
Figure 5.3: Free cash flow to the firm

9.000
8.000
7.000
DKK Millions
6.000
5.000
4.000
3.000
2.000
1.000
-
2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E Terminal
Year
As illustrated in figure 5.3, the FCFF keeps rising steadily before stabilizing towards the end of the period,
corresponding with the development of NOPAT. The terminal FCFF is projected to be a lower value than
2021E, due to the many aspects mentioned. The level of the FCFF is however still significant, and indicates
that LEGO will continue to have success.
5.5 Part Conclusion

In the Budget and Forecasting chapter the forecasted financial statements, which will be used in the next
chapter, were computed using the sales-driven budgeting approach. Therefore accounting items were
projected in relation, either directly or indirectly, by the forecasted sales growth.
A period of 10 years was deemed appropriate in length until the terminal period, at which point LEGO is
expected to reach a form of steady state.
LEGO is expected to maintain high levels of sales growth due to the opportunities in the different markets
and its growing success in the girl segment. Its costs-to-sales ratios are expected to increase during the
period, and has been estimated to grow by 1,5% every year for items; production cost, sales and distribution,
administration, other and depreciation.
The tax rate is projected to remain stable at 25%, the Danish corporate tax rate. Unusual items have been
projected to zero, as they are considered very difficult to project accurately
62
Further the NWC and the NCCOA were found, as the individual items were projected. All but one, fixed
assets under construction which is projected to grow 0,3 percentage points every year, were projected to
maintain a stable level. The level was found through a 3 year historical average and set for that the entire
period.
With all the projected numbers, it was possible to project NOPAT, ROIC and FCFF. While the ROIC is
projected to decline over the period, the FCFF is projected to increase until the terminal period. A decrease
in ROIC is a natural development, as the high levels of ROIC LEGO has at the moment will be unsustainable
for the long term.
6. Valuation
This chapter will utilize prior analysis, forecasts and estimations to compute a fair value of the LEGO Group
as of the 31st of December 2012.
This chapter will examine the two selected valuation models, the Discounted Cash Flow model and the
Economic Value Added model. Both positives and negatives will be explored, and the reasoning behind
choosing the models will be described. Subsequently key elements, based upon the prior analysis in the
thesis and vital to the valuation, will be determined.
6.1 Valuation Models

A wide array of different valuation methods to estimate the value of a company exists. This thesis has chosen
to apply two of the more commonly used ones, the Discounted Cash Flow model (DCF) and Economic
Value Added model (EVA).
6.1.1 Discounted Cash Flow

The DCF model’s objective is to compute a company’s Enterprise Value (EV). In this model all future cash
flows are estimated and discounted, hereby providing their present values. The cash flows are discounted at
the weighted average cost of capital (WACC). The estimation of WACC can be troublesome and difficult,
but is crucial, as it is very influential in regards to valuation. The WACC will therefore be discussed and
estimated in a section later in the chapter.
The model computes the value of a company through the following equation:
63
Theoretically, the DCF model is arguable the most sound method of valuation, as it looks forward and
depends on expectations rather than historical results. The model is focused on cash flow generation, which
makes accounting policies a non-factor and minimizes the risk of a skewed valuation. It is based on a
specified budgeting period, which allows for detailed projections, while the WACC allows for adjustment to
risk.
Some of the strengths of the model are also some of the biggest weaknesses. The detailed projection of
financial statements is highly dependent on the quality of these assumptions and estimations, as are the value
of the WACC. As LEGO is in state where high growth is expected in the coming years, due to the various
reasons mentioned in prior analysis, it makes it very difficult to project accurately, entailing a DCF valuation
with rather high degree of uncertainty. In 2006 few would have thought that LEGO’s sales would grow
140% and comprehensive income would grow 255% in just 6 yearsclv.
6.1.2 Economic Value Added

The EVA model, also called Residual Income model, was developed by Stern Stewart & Coclvi. The model
also computes a company’s EV. The company’s value is determined through Invested Capital (IC), plus the
present value of all future EVAs. The EVAs is the after tax operating income subtracted the cost of capital
employedclvii.
The EVA model shares most of the advantages and disadvantages of the DCF model, as the estimation
difficulties are prominent. EVA does however relate earnings to respective risk factor, which is an
advantage. Opposed to the DCF model, EVA is influenced by companies’ accounting principles, hence it is
very difficult to compare EVAs based on distinct accounting principles.
6.2 Valuation assumptions

This thesis is based on a number of assumptions, which are important to state before the valuation process in
undertaken. It is assumed LEGO Group is an ongoing company, which suggests the company will continue
to compete in perpetuity. This is a necessary assumption to compute the terminal value of the company.
The two-stage model simplifies the forecasting somewhat. Forecasting all future cash flows is practically
impossible as the uncertainty entailed with forecasting farther and farther way is very high. Therefore a
growth factor for the terminal period is determined, which will then account for future growth after the
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forecasting period. The growth level for the steady state is projected to be around the growth of the industry,
which is forecast to be around 3% a yearclviii.
6.3 Weighted Average Cost of Capital

Since the thesis centers on the DCF and the EVA valuation models it is crucial to apply the correct
opportunity cost. The WACC is an integral and important component, as it serves as the opportunity cost for
both models. WACC accounts for differences in required rate of return for both equity and debt, as it is a
weighted average of the total required rate of return in a company. The equation for the WACC is:
Where E/EV is targeted level of equity to enterprise value, D/EV is targeted level of debt to enterprise value,
re is required rate of return on equity or cost of equity and rd is required rate of return on debt on cost of debt.
This thesis has chosen to capitalize the operating leases, placing them as assets on the balance sheet and
correspondingly placed as long-term debt. Consequently, the WACC-formula must be adjusted to account
for the change.
Where AEV is adjusted enterprise value, COL is capitalized operating leases and rCOL is cost of capitalized
operating leases.
6.3.1 Capital Asset Pricing Model (CAPM)

To estimate the re the CAPM will be applied. With the CAPMM model the cost of equity can be determined
through the following equation:
Where rf is the risk-free interest rate, is the systematic risk on equity and rm is the return on market
portfolio. In the CAPM model it is assumed that an investor has a diversified portfolio, as then only
systematic risk needs to be compensated. For LEGO, who is privately held, it can be assumed that the
owners do not have a diversified portfolio, therefore Damodaran suggest including the unsystematic risk
in the calculation of cost of equity. Plenborg & Petersen (2006)clix did a survey, where, of 39 analysts,
only 6% noted that they adjusted for this particular risk. The few who did chose to raise the cost of
equity by 1-3%. Further 33 of the 39 found it irrelevant. The survey clearly shows that in Denmark it is
unusual to adjust for the risk, hence the thesis will not adjust the cost of equity for unsystematic risk.
65
The subsequent three sections will contain an estimation of each parameter before the final calculation
of LEGO’s re.
6.3.1.1 Risk-Free Rate

The risk-free rate states how much an investor can earn without incurring any risk. General practice is to
use the effective rate of government bond, as the risk of default is almost non-existent and government
bonds therefore represent a good reference for a risk-free rate. Ideally, every cash flow should be
discounted using a government bond with a matching duration. However, due to several complications
and a very high increase in complexity with this methodclx, it is common practice to use ten-year
government bond. As LEGO is based in Denmark a ten-year zero-coupon Danish government bond has
been chosen. The ten-year bond is further a good match with the chosen forecast period, which is also
10 years.
The credit crisis in Southern Europe has greatly affected the Danish ten-year government bond, as
investors, who prefer government bonds, have substituted for more trustworthy countries such as
Denmark. Therefore it has been deemed more appropriate to apply a 5 year arithmetic average of the
Danish ten-year zero coupon bond, see appendix 5 for development in bond yields.
The chosen risk-free rate for the subsequent valuation of LEGO will be 3,04%clxi.
6.3.1.2 Beta
Beta indicates the relative risk of a company in relation to the market. General practice is to calculate the
beta for the CAPM model based on the company’s stock return and the return from the market portfolio.
LEGO, however, is a privately held company, hence the described method is not possible. According to
Damodaran there is three possible ways to estimate beta for a privately held companyclxii:
 Accounting beta, which uses the change in earnings compared to the return on the market portfolio,
but as LEGO only report earnings once a year and have changed greatly as a company, this method
would be less than optimal.
 Fundamental beta, which relates beta from comparable companies to different variables, such as
revenue growth and change in earnings.
 Bottom-up beta, which compares historical betas from comparable companies in the same industry.
This is the approach this thesis will take, as Mattel and Hasbro are both public companies.
The bottom-up beta approach will first estimate the average beta for the publicly traded comparable firms,
LEGO’s peers. Mattel’s and Hasbro’s betas will be calculated as a 5 year average, based on historical
66
monthly returns for their stock, in accordance with Koller, and the market in the period: 31st of December
2007 to 31st December 2012.
Table 6.1 Mattel Hasbro

Beta 5 year 0,801 0,799
The total table of returns can be found in appendix 6.
The beta value for Mattel and Hasbro, depicted in table 6.1, reflect the beta value for the equity, levered beta,
therefore it is necessary to adjust for how the equity is financed.
According to Damodaranclxiii the best way to unlever the beta is Modigliani and Miller’s method, which is the
following:
As the financial statements for Mattel and Hasbro have already been reformulated the unlevered betas can be
computed, the values is shown in table 6.2
Table 6.2 Mattel Hasbro

NIBD, Thousand USD 507.979 1.395.369
Amount of shares 338.998.144 128.642.089
Share price, Dec 2012 26,32 30,14
Equity value 8.922.431 3.877.273
Beta Unlevered 0,77 0,65
LEGO’s market value of equity is unknown. Damodaran states two usual approaches to this problemclxiv, as
the debt/equity ratio can be assumed to be the industry average or the debt/equity ratio can be assumed to be
optimal. Mattel and Hasbro have ratios of 5,7% and 20,8% respectively. An average of just these two would
be an inaccurate assumption of the debt/equity ratio of LEGO, as LEGO’s debt is lower in 2011 than it was
in 2006clxv while the company has had great success. Further LEGO has outperformed its competitors and
had significant earnings, indicating that a market value of its equity would be significant compared to its
debt. Lastly LEGO has paid off all of its big loans, why the debt is not considered significant as it the value
of the debt constitutes less than 25% of its profits for 2011clxvi. Therefore the debt/equity ratio has been
estimated to be equal to the industry leader, which is Mattel. The debt does not include capitalized operating
leases, as a correction for these will be made in the WACC itself. The unlevered beta is the arithmetic
average of Mattel and Hasbro.
67
LEGO’s beta will therefore be:
The beta, which will be used in the subsequent calculation of WACC will be 0,74.
6.3.1.3 Market risk premium

The market risk premium is the difference between expected return on the market and the risk-free rate.
There are several different ways to measure the premium and it is a much debated topic in finance.
Projecting the premium is very difficult, as these projections rely on either historical data or expectations.
History has shown that neither detailed expectations nor historical data can accurately estimate the future
market premium.
Damodaran, who is well renowned in this field, estimated Denmark had a market risk premium of 6% in
2012clxvii. To compare this to other experts this thesis have chosen to use an extensive survey of market risk
premiums, where 3 students from IESE Business School made an extensive survey in order to capture a
wider picture of the market risk premiums used by analyst, professors, managers etc. They were asked to
disclose the market risk premium they used and in Denmark there were 43 answers with an average of
5,5%clxviii. Therefore this thesis has chosen to use the average of the two, illustrated in the table 6.3.
Table 6.3: Market risk premium 2012

Damodaran 6%
IESE 5,50%
Average 5,75%
Source: Own creation based on Damodaran and IESE
Hence the market risk premium used in the valuation for LEGO subsequently will be 5,75%.
6.3.1.4 Cost of equity

All parameters of CAPM have now been found and the cost of equity can be calculated
The cost of equity which will be used in the subsequent valuation will be 7,295%
68
6.3.2 Cost of debt
The cost of debt is the market interest rate a company has to pay on its debt. For companies who have
publicly traded bonds outstanding, the yield to maturity can be used as a proxy for the cost of debt. If a
company does not have publicly traded bonds, but have received a rating, it is common to calculate the cost
of debt by estimating default premium and adding the risk-free rateclxix. However, LEGO has neither, and
therefore it is necessary to estimate a synthetic rating which can be calculated, using Damodaran’s
guidelinesclxx, by applying numbers from LEGO’s financial statements.
First, the interest coverage ratio (ICR) has to be computed, which is achieved through the following
equationclxxi:
The EBIT has been adjusted for operating leases. According to Damodaranclxxii a 36,58 ICR translates to an
AAA rating. As the rating has been found, the corresponding default premium can be looked up in
Damodaran’s data setsclxxiii. LEGO’s ICR translates to default premium of 0,4%.
The formula for calculating the cost of debt after tax is:
As all components for the formula for the cost of debt after tax has been found, we can calculate the cost of
debt after tax.
It is a very low cost of debt, which can be attributed to both LEGO’s high ICR and its subsequent low default
premium. Another factor is the low risk-free rate, which can be attributed to the financial credit crisis.
6.3.3 Cost of Capitalized Operating Leases

The cost of operating leases was estimated in chapter 4 as an average of indexed corporate bonds.
Table 6.4: Cost of Operating Leases 2007 2008 2009 2010 2011 Average
UK Corporate Bond AA 5,90% 7,20% 5,80% 5,60% 4,70% 5,80%
US Aaa Corporate Bond 5,60% 5,60% 5,30% 4,90% 4,60% 5,20%
Average 5,70% 6,40% 5,50% 5,30% 4,70% 5,50%
69
The cost of operating leases has to be adjusted for tax.
6.3.4 Capital Structure

The last component in the WACC needed is the capital structure. Theory argues that market values of equity
should be usedclxxiv, which is problematic since to compute the market value of equity the WACC is needed.
Therefore it is necessary to estimate the future value of equity. For public companies this is done by
multiplying amount of shares with share price. This thesis will have to take another approach, as LEGO is
unlisted.
As it has already been assumed, in the beta section, that LEGO’s debt to equity ratio is 0,057, and as it is
necessary to be consistent in assumptionsclxxv, LEGO’s debt to equity ratio will be held at 0,057 for the
capital structure section. As LEGO’s debt is not traded publicly, the book value of the debt will be used for
the valuationclxxvi. This is common practice as many companies do not trade their debt publicly. When
calculating the debt to equity ratio there were three components; the ratio, debt and market value of equity.
As the ratio has been assumed and the debt is known, the market value of equity can be estimated by the
following formula.
As seen in the formula the equity value amounts to 16.837,75 million DKK.
The book value of debt is found to be 958,62 million DKK.
The book value of operating leases will be used, as LEGO had not published any new financial statements
before the cutoff date, the value of the operating leases will be assumed to be the same as December 31st
2011. This is a realistic assumption as LEGO had very close values of operating leases in 2010 and 2011,
with 2010’s value being a little higher. The book value of the operating leases is therefore 1939,13 million
DKK.
The sum of the three drivers, amount to 19.735,5 million DKK, constituting LEGO’s market enterprise
value.
6.3.5 WACC
All components for the WACC have been found and it can be computed:
70
The level for the WACC seems reasonable, and will therefore be used for the subsequent valuations in the
DCF and EVA models.
6.4 Terminal Period

The terminal period is the second part of the two-stage forecasting period. It represents the value of the
steady state which LEGO will reach. As the terminal period is ongoing, it will be calculated as a perpetuity
of cash flowsclxxvii.
The growth level has been established earlier to be 3%, which is in accordance with the forecasted industry
growth globallyclxxviii. LEGO’s core markets might be more stagnant, but as LEGO look to enter the
emerging markets more significantly and strengthen its position in developed markets, it is an appropriate
growth level. The growth rate is further reinforced by theory, as it is believed that 3% is a realistic level of
long time sustainable growthclxxix.
LEGO’s forecasted growth for the budgeting period is very high, and is therefore also uncertain to a point.
Projecting a terminal period 10 years away is very uncertain and as the terminal period affect the final
valuation greatly, it is necessary to be cautious. Therefore this thesis will apply a risk premium to account for
the uncertainty.
The risk premium has been estimated to be a 1/5 of the calculated WACC and will therefore be 1,35%.
6.5 Discounted Cash Flow Valuation

Table 6.5 on the next page illustrates the DCF model and the calculated value of the LEGO Group.
All FCFF values were calculated in chapter 5 and were slotted into the model. The discount factor and PV
were calculated by the following equations:
71
Table 6.5: DCF Valuation of LEGO Group
Budget period
Million DKK 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E TV
Free Cash Flow 3.491 3.827 4.576 5.120 5.810 6.489 7.132 7.336 7.715 8.270 7.596
WACC 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 6,75%
Discount factor 0,94 0,88 0,82 0,77 0,72 0,68 0,63 0,59 0,56 0,52 0,52
Discounted value 3.270 3.358 3.761 3.942 4.190 4.384 4.514 4.348 4.284 4.302
Terminal value 148.771
Terminal Value 77.382,88

Sum of PV FCFF 40.352,37
Enterprise value 117.735,20
NIBD 2.897,75
MIN 230,02
Equity value 114.607,50
Book value of MIN 23

Invested capital 11772,46
MIN's share of IC 0,20%
Estimated value of MIN 230,02
As the table shows, the value of LEGO is 114.607,5 million DKK.
6.6 EVA Valuation

Table 6.6 on the next page displays the underlying factors of the EVA model and the calculated equity value
of LEGO.
72
Table 6.6: EVA Valuation of LEGO Group
Budget period
Million DKK 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E TV
NOPAT 5.391 6.265 7.089 7.908 8.669 9.317 9.810 10.297 10.680 10.839 8.687
IC , primo 9.873 11.772 14.210 16.723 19.511 22.371 25.199 27.877 30.838 33.803 36.372
WACC 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 6,75% 8,11%
Cost of capital 667 795 960 1.130 1.318 1.511 1.702 1.883 2.083 2.283 2.948
EVA 4.724 5.470 6.129 6.778 7.351 7.806 8.108 8.414 8.597 8.556 5.739
Discount factor 0,94 0,88 0,82 0,77 0,72 0,68 0,63 0,59 0,56 0,52 0,52
Discounted terminal value 58.464
Discounted value of EVA 4.425 4.799 5.037 5.219 5.302 5.273 5.131 4.988 4.774 4.450
IC primo 9872,75
Terminal value 49.398,63
Sum of PV EVA 58.463,86
Enterprise value 117.735,24
NIBD 2.897,75
MIN 230,02
Equity value 114.607,47

As depicted in the tables 6.5 and 6.6, both models compute equal equity value can the valuation can thus be
assumed accurate, given the assumptions taken in the thesis. LEGO Group is therefore valued at
114.607.473.698,26 DKK or 114,6 billion DKK as of the 31st of December 2012.
6.7 Sensitivity Analysis

In order to test the validity of the valuation, it is necessary to perform a sensitivity analysis, as this should
disclose any flaws or errors in the valuation. The sensitivity analysis assesses how changes in the key inputs
alter the value of the company.
To effectively explore the uncertainty of the estimated value and to what degree these key inputs are able to
alter the valuation, the thesis has chosen a 2-dimensional model, which will display the effect from 2 inputs
at a time.
The specific inputs which will be explored are: components of the WACC, growth rate in terminal the
terminal period, and changes in terminal WACC. The components of the WACC which will explored are
LEGO’s cost of debt (COD), cost of capitalized operating leases (COCOL) and the cost of equity (COE),
which includes market risk premium (MRP) and beta.
6.7.1 Risk premium for the Terminal period and Terminal Growth
First the impact of changes to the risk premium incorporated for the WACC in the terminal period and the
growth in the terminal period for the terminal value will be explored. Table 6.7 displays the percentage
73
change in the terminal value at changes of 0,5% in risk premium charged the terminal WACC and 0,25% in
terminal growth.
Table 6.7: Percentage change in terminal value

Risk premium TVW/Terminal growth 2,0% 2,25% 2,5% 2,75% 3,0% 3,25% 3,5% 3,75% 4,0%
6,1% 46% 55% 66% 78% 92% 109% 129% 154% 184%
6,6% 25% 32% 40% 49% 59% 71% 85% 101% 120%
7,1% 8% 14% 20% 27% 34% 43% 53% 65% 78%
7,6% -5% -1% 4% 9% 15% 22% 29% 38% 47%
8,1% -16% -13% -9% -5% 0% 5% 11% 17% 24%
8,6% -26% -23% -20% -16% -12% -8% -4% 1% 7%
9,1% -34% -31% -28% -26% -23% -19% -16% -12% -7%
9,6% -40% -38% -36% -34% -31% -28% -26% -22% -19%
10,1% -46% -44% -43% -41% -38% -36% -34% -31% -28%
The numbers indicated in red denotes a negative change of the terminal value, while the numbers in green
denote a positive change. Table 6.7 illustrates how sensitive the terminal value is to changes in these values,
e.g. a change in the risk premium of 1% with the same growth equals either a negative change in terminal
value of 23% or a positive change of 34%. Such changes would drastically alter the final valuation, as the
terminal value represents a large part of the total value, why it is imperative to estimate the values as
correctly as possible. The table underlines the importance of the WACC level, why this thesis will now
explore the components of the WACC.
6.7.2 Cost of Debt and Cost of Capitalized Operating Leases

To explore how the different components of the WACC influence the total valuation, the thesis will first look
at how changes to the COD and COCOL affect the WACC level. Subsequently the percentage change in the
DCF valuation from the different values will be explored.
Table 6.8: WACC change in relation to change to COD and COCOL

Cost of debt / Cost of COL 2,13% 3,13% 4,13% 5,13% 6,13%
0,58% 6,46% 6,56% 6,66% 6,76% 6,85%
1,58% 6,51% 6,61% 6,71% 6,80% 6,90%
2,58% 6,56% 6,66% 6,75% 6,85% 6,95%
3,58% 6,61% 6,71% 6,80% 6,90% 7,00%
4,58% 6,66% 6,75% 6,85% 6,95% 7,05%
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Table 6.8 displays that the WACC is affected to a higher degree by changes in COCOL, as a 1% change to
COCOL increases the WACC by 0,1% or decreases the WACC by 0,09 %, while changes to COD only
affect by +0,05% and -0,04% at a level of 1% change. These values are not significant and the subsequent
effect on the DCF valuation can be seen in table 6.9 below.
Table 6.9: DCF Value at new WACCs from change in COD and COCOL Percentage change in equity value
Cost of debt / Cost of COL 2,13% 3,13% 4,13% 5,13% 6,13% 2,13% 3,13% 4,13% 5,13% 6,13%
0,58% 123.295 120.249 117.347 114.577 111.931 7,58% 4,92% 2,39% -0,03% -2,34%
1,58% 121.771 118.797 115.961 113.254 110.667 6,25% 3,66% 1,18% -1,18% -3,44%
2,58% 120.283 117.379 114.607 111.960 109.429 4,95% 2,42% 0,00% -2,31% -4,52%
3,58% 118.830 115.993 113.284 110.695 108.218 3,68% 1,21% -1,15% -3,41% -5,57%
4,58% 117.411 114.638 111.990 109.457 107.033 2,45% 0,03% -2,28% -4,49% -6,61%
The table shows the outer extremes to be +7,58% and -6,61%, which are not considered significant at
considerate changes to both COD and COCOL. It can be concluded that the value of LEGO is not particular
sensitive to changes in COD or COCOL. The result was expected due to the capital structure of LEGO. The
weights of LEGO’s WACC are 4,86% from COD and 9,83% from COCOL, while COE contributes with
85,32% Therefore the thesis will explore the parameters of the COE.
6.7.3 Market Risk Premium and Terminal Growth

The thesis will therefore explore changes to the COE, starting with one component of the COE, the MRP.
Table 6.10: Percentage change in DCF valuation

Market risk premium / Terminal growth 2,0% 2,5% 3,0% 3,5% 4,0%
MRP WACC
0,0375 5,49% 19,5% 29,9% 43,1% 60,5% 84,7%
0,0475 6,12% 2,1% 9,1% 17,8% 28,7% 42,9%
0,0575 6,75% -11,0% -6,0% 0,0% 7,3% 16,4%
0,0675 7,39% -21,3% -17,6% -13,2% -8,1% -1,9%
0,0775 8,02% -29,5% -26,7% -23,5% -19,7% -15,3%
Table 6.10 illustrates how the estimation of the market risk premium is very important, as changes to MRP
alters the total WACC significantly, which then alters the DCF valuation. The table further displays how
changes to the MRP alters the valuation more than changes to terminal growth, which is logical, since the
WACC is used to discount all cash flows and impacts terminal value, while terminal growth only relates to
terminal value.
75
6.7.4 Beta Value and Terminal Growth
To further investigate components of COE, the effects of changes to the beta will be explored.
Table 6.11: Percentage change in DCF valuation in relation to change in Beta

Terminal growth 2,00% 2,25% 2,50% 2,75% 3,00% 3,25% 3,50% 3,75% 4,00%
Beta WACC
0,540 5,77% 11,1% 15,2% 19,8% 24,9% 30,6% 37,1% 44,6% 53,3% 63,4%
0,590 6,02% 4,6% 8,2% 12,1% 16,5% 21,4% 26,9% 33,1% 40,2% 48,5%
0,640 6,26% -1,1% 2,0% 5,4% 9,1% 13,3% 18,0% 23,2% 29,2% 36,0%
0,690 6,51% -6,3% -3,6% -0,6% 2,6% 6,3% 10,3% 14,7% 19,8% 25,5%
0,740 6,75% -11,0% -8,6% -6,0% -3,1% 0,0% 3,5% 7,3% 11,6% 16,4%
0,790 7,00% -15,3% -13,2% -10,9% -8,3% -5,6% -2,6% 0,8% 4,5% 8,6%
0,840 7,25% -19,2% -17,3% -15,2% -13,0% -10,6% -7,9% -5,0% -1,8% 1,7%
0,890 7,49% -22,8% -21,1% -19,2% -17,3% -15,1% -12,8% -10,2% -7,4% -4,4%
0,940 7,74% -26,1% -24,5% -22,9% -21,1% -19,2% -17,1% -14,9% -12,4% -9,7%
Table 6.11 shows that the value of beta can significantly impact the value of LEGO, though not as
significantly as change to the MRP. Again the terminal growth is not as important a factor to the DCF
valuation, as changes in beta. Naturally this is due to the significant effect the beta has on the WACC. A
decrease of the beta value by of 0,05, increases the total valuation by 6,3%. Hence a good estimation of beta
is needed.
6.7.5 Summary of sensitivity analysis

The analysis in this section provided an overview of how different drives affect the value of LEGO. Certain
drivers were found to be of greater significance than others.
The first explored was how risk premium changes in the WACC used for the terminal value along with
changes to terminal growth affected the value of the terminal period. The conclusion was that changes to the
WACC were most influential.
Then an exploration of the drivers of the WACC was undertaken, and the first drivers explored were COD
and COCOL. The significance of these was not high, as the final valuation was not greatly influenced by
changes to these. The reason was the capital structure of LEGO, as the weight of COE in the WACC was
85,32%, hence changes to COE would be explored.
COE’s primary drivers are beta and MRP. It was found the changes to MRP greatly affected the WACC and
therefore the final valuation. Further changes to beta also had significant impact on the WACC, and
subsequently the valuation, but MRP was found to be the most influential component.
76
Hence, the CAPM is a primary driver for the final value of LEGO, as the CAPM was used to calculate COE,
influencing the level of WACC greatly, which then impacted the total value significantly.
6.8 Multiples Comparison

The DCF valuation is only as accurate as the projected forecasts and inputs, therefore a multiples analysis
will be conducted to bring perspective to the values found.
Multiples comparisons are generally used for comparing performance for companies, as they provide ease
and quick measures. However, since they are quick and easy they are not very thorough and have several
shortcomings. As the peer group of LEGO does not have equivalent growth potential, which is importantclxxx,
the numbers might provide a skewed valuation.
The peer group used is still Mattel and Hasbro, as they are the only two other toy manufacturers on the level
of LEGO. A suitable peer within the industry in regards to size and sales growth simply does not exist,
theory suggest that a company with similar growth and financials could be used, but for this thesis, Mattel
and Hasbro have been chosen.
The data used has been collected from Thomsen One Banker. As LEGO is a private company, its ratios
cannot be found, and the listed ratios, for LEGO, are based upon the forecasted numbers found earlier. The
multiples used were Enterprise Value (EV) / Sales, EV/EBITDA, EV/EBIT and P/E.
6.8.1 EV/Sales
This ratio describes the relationship between the enterprise value and sales. The ratio provides a measure of
how much it costs to buy a company’s sales. LEGO’s forecasted growth is based on organic growth, while
the numbers from Thomsen One Banker is based on total sales
Table 6.12 EV/Sales Sales growth

Company/Year 2012 2013 2014 2012 2013 2014
Mattel (One Banker) 2 2,3 2,2 2,5% 6,5% 4,6%
Hasbro (One Banker) 1,3 1,5 1,5 0,0% 0,6% 3,7%
LEGO forecast 4,97 4,15 3,54 23% 20% 17%
Table 6.12 clearly displays a much higher ratio for LEGO than for the peer group, which is to be expected
due to high forecasted growth for LEGO. LEGO’s ratio does drop from 4,97 in 2012 to 3,54 in 2014, starting
to near the peer group’s ratio. According to the projected forecasts, LEGO will in 2018 have a ratio of 2,17.
LEGO is by far the most expensive of the company’s when looking at this ratio.
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6.8.2 EV/EBITDA
This ratio describes the relationship between enterprise value and EBITDA. It is considered a more accurate
measure then P/E, due to the fact that it is independent of capital structure. The higher the ratio the more
expensive the company is relative to its EBITDA.
Table 6.13 EV/EBITDA EBITDA margin

Company/Year 2012 2013 2014 2012 2013 2014
Mattel (One Banker) 10,5 10,4 9,7 18,8% 22,0% 22,5%
LEGO forecast 14,55 12,44 10,96 34% 33% 32%
Table 6.14 shows that LEGO’s ratios are higher than its peer group, but in 2014 the ratio is 10,96 for LEGO,
while it is 9,7 for Mattel. This shows a trend that in the future LEGO’s ratios might be lower than its peers’.
LEGO’s EBITDA margin is significantly higher than its competitors, which can be attributed to its premium
prices and optimized operating model.
6.8.3 EV/EBIT
This ratio is quite similar to the previous, but it accounts for depreciation and amortization.
Table 6.15 EV/EBIT EBIT margin

Company/Year 2012 2013 2014 2012 2013 2014
Mattel (One Banker) 12,3 11,8 11 16,1% 19,3% 19,9%
LEGO forecast 15,95 13,72 12,13 31% 30% 29%
As the values of EV/EBIT are depicted in table 6.15, it is clear that there is not a significant difference from
EV/EBITDA to EV/EBIT. Hasbro has the largest depreciations and amortizations as its margin drops the
most, which is also evident in its ratios, as these increase the most. LEGO is the most expensive company
once again.
6.8.4 P/E
As the P/E ratio describes the relationship of stock price with the earnings per share, it is not possible to
compute for LEGO. Instead the relationship between EV and NOPAT has been computed for LEGO, which
should provide a similar ratio.
78
Table 6.16 P/E Net income margin
Company/Year 2012 2013 2014 2012 2013 2014
Mattel (One Banker) 16,5 15,6 14,2 12,0% 14,3% 14,8%
Hasbro (One Banker) 13,8 15 13,9 8,2% 9,2% 9,6%
LEGO forecast 21,26 18,29 16,17 23% 23% 22%
LEGO’s ratios are the highest again, shown in table 6.16, but with a decreasing trend, which is due to
forecasted growth resulting in a higher NOPAT. LEGO’s net income margin is significantly better than its
peers. Hasbro is the underperformer with net income margins below 10%. The high P/E ratio for LEGO
suggests high expectations for the future or an inflated EV.
6.8.5 Valuation of LEGO Based on Peer Ratios

The following table illustrates LEGO’s EV, based on an average of its peers average ratios and forecasted
income statement.
Table 6.17: LEGO's EV based on average peer ratio

Million DKK 2012 2013 2014
EV/Sales 38.015 52.529 59.842
EV/EBITDA 71.697 85.193 90.951
EV/EBIT 79.423 91.466 97.349
P/E 81.670 95.851 99.594
Table 6.17 illustrates that if projecting LEGO’s EV based on sales, the value is much lower than the other
parameters. The ratio in particular does not take into account what the company’s costs are, and as LEGO’s
cost are low in relation to its sales, estimating its value based on sales will undervalue LEGO severely. All
values calculated are below the DCF valuation performed earlier, which is to be expected with the difference
in growth expectations for the companies. Looking to 2014, however, the value does begin to near the
projected EV of LEGO
6.8.6 Summary of Multiples Comparisons

The multiples comparisons analysis showed that LEGO’s ratios are higher than its peers, indicating that the
thesis’ value LEGO highly, but also an indication of LEGO’s outperformance of its competitors. The 2012
numbers can be expected to be relatively accurate as it is only projected a year ahead and several reports
from 2012 indicated LEGO’s continued growth. It was not possible to compare values for LEGO with
Thomsen One Banker, as LEGO is a privately held company.
6.9 Valuation – Part Conclusion

The valuation chapter is the focal point of the thesis, as it utilizes all information found throughout the thesis
in order to estimate the enterprise value of LEGO Group.
79
First the level of WACC was determined. The cost of debt was estimated to 2,58%, the cost of capitalized
operating leases to 4,13% and the cost of equity to 7,295%, resulting in a WACC of 6,755%.
Subsequently the two valuation models were applied, which were merely a mathematically deduction of the
forecasts, established in the prior chapter. The models both estimated the value of LEGO, with the assumed
parameters, to be 114.607,47 million DKK.
Thereafter a sensitivity analysis was applied, in order to account for the uncertainty which is associated with
the valuation. The components explored were risk premium for the terminal period, terminal period growth
and changes in the WACC. It was found that changes to the WACC was most influential to the valuation,
and changes in cost of equity in particular was influential, which was attributed to the capital structure of
LEGO, which 85,32% equity.
Lastly multiples comparisons were used, in order to compare LEGO to its peers through different ratios
found through Thomsen One Banker. The multiples comparisons showed that LEGO is valued highly by this
thesis, but the multiples comparisons are not quite accurate due to the assumption that peers must have
similar growth rates, which they do not in this case.
7. Conclusion
The aim of the thesis has been to estimate LEGO’s fair value as of the 31st of December 2012. LEGO was
chosen due to their recent success and their near death experience in 2004. The huge turnaround is highly
interesting, and further the bright outlook made the company value an interesting topic.
In order to compute a credible valuation of LEGO a high level of information is needed. Therefore a
presentation of the company was made, followed by a strategic and financial analysis.
Through the chapter “Presentation of LEGO Group”, an insight into the historical developments of the
company was achieved. The late success since JVK took over was described and attributed to the
optimization of the operating model. LEGO is firmly entrenched in the top of the traditional toys and games
market, currently the third largest manufacturer of toys, while sitting heavily on the construction toys
segment. LEGO is experiencing significant growth in the stagnant North American market, the Asian market
and the Eastern European market. Its new product for girls, LEGO Friends, is experiencing success and
creating growth in stagnant market.
Following the presentation, a strategic analysis was performed, shedding light upon the context in which
LEGO operates and the different factors influencing LEGO. LEGO’s brand was found to be an important
strength of the company along with capabilities such as strong management, organizational and
technological. The company’s weaknesses are primarily their single category focus, their high prices and the
80
dependence on external licensing rights. The primary opportunity for LEGO is to expand heavily to the
growing emerging markets, as they are threatened by age compression and competition in their core markets.
The financial analysis showed LEGO had an increasing ROE in the analyzed period, primarily driven by an
increasing ROIC. The financial leverage of LEGO decreased throughout the period as loans were paid off in
the start of the period, resulting in an operating model primarily equity financed. LEGO was compared to its
peers, and was shown to be dominant in the financial ratios as its peers had far lower ROE and ROIC. The
risk profile showed that LEGO currently both low financial and operating risk.
The strategic and financial analysis enabled the thesis to forecast LEGO’s statements for the next 10 years,
as well as a terminal period. LEGO is expected to continue having high sales growth, though gradually
declining. The cost-to-sales ratios are expected to increase during the period for certain items, resulting in a
profit margin of 21% in 2021E and 16% for the terminal period. The tax rate is forecasted to remain constant
and unusual items forecasted to zero. The forecasted balance sheet items were estimated based on historical
3-year average and projected to remain constant in relation to sales, as only one item showed a particular
trend. Fixed assets under construction was projected to increase 0,3 percentage points every year until
2021E. As both statements had been forecasted the NOPAT, ROIC an FCFF were calculated. ROIC is
projected to decline, while FCFF and NOPAT are projected to increase through the period. The terminal
value of FCFF and NOPAT is estimated to be lower than 2021E levels as growth is only 3%.
Subsequently, as all inputs had now been found, the valuation could be computed. The DCF and EVA model
had been chosen, and both models estimated the value of LEGO to be 114.607,5 million DKK. The
sensitivity analysis found that the value was in particular driven by the value of the WACC. The estimated
WACC level had been found to be 6,755%, by applying CAPM to find the cost of equity, corporate bonds to
find the cost of capitalized operating leases and Damodaran’s principles on estimating unlisted companies
dost of debt through synthetic ratings. The sensitivity analysis further showed that the WACC was most
sensitive to changes in the cost of equity, which can be attributed to the capital structure of LEGO. The cost
of equity was most sensitive to changes in the market risk premium and to a lesser extent the beta value.
The multiples comparisons analysis was conducted in order to compare LEGO to its peers through ratios
found at Thomsen One Banker. As LEGO is unlisted, LEGO could not be compared to listed values for
itself. The multiples comparisons analysis showed that LEGO is valued highly by the thesis. Due to the sales
growth differences between LEGO and its peers, the multiples comparisons cannot be considered highly
accurate.
The estimated value of LEGO is considered high, as the share value of Mattel is around 9 billion dollars.
This is due to the forecasted growth of sales and continued high profit margins, and based on the
performance of LEGO in the analyzed period, it is considered a representative value of LEGO Group.
81
8. Perspectives
This chapter will discuss and outline perspectives not taken into account in the thesis. Naturally new relevant
information regarding LEGO and its value has surfaced after the cut-off date, among others the annual report
for 2012 has been published.
The annual report shows the progress for 2012 was very close to the projected values in chapter 5, as the
sales for 2012 was 23.405 million DKKclxxxi and was projected to be 23.039 million DKK. This emphasizes
that LEGO is not slowing down just yet. Costs are similarly close to the projected values. The relative
accurate forecasted values, bodes well for the accuracy of the value of LEGO.
On the 22nd of February 2013, an analyst of the American investment bank, Needham, estimated LEGO’s
value to be around 20 billion USD, which, on that date, corresponded to 113.144 million DKK. The value is
very close to the value estimated in the thesis, which shows the value to be a realistic estimation.
LEGO’s future keeps looking bright, as they keep investing in their capacityclxxxii. Their factory in Czech
Republic is expected to have near 2000 employees in 2015, an increase of 800. Meanwhile LEGO is
downsizing their production in Denmark. However the investment in increased capacity in low-wage
countries is a sign of their expectations for future demand.
The Eastern European and Asian markets did not continue their double digit growth, as growth returned to
levels of 4,5% and 6,2% respectively. This does not change the outlook for LEGO in the markets, as the caps
in the markets are far from reached. Further the growth rates are still good, though not exceptional.
The perspectives explored enforce the validity of the estimated value of future of the LEGO Group.
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Websites:
www.business.dk
www.bloomberg.com
www.borsen.dk
www.brickpicker.com
www.businesssourcecomplete.com
www.education.com
www.finance.yahoo.com
www.finans.tv2.dk
www.globaltoysnews.com
www.hasbro.com
www.ing.dk
www.investopedia.com
www.LEGO.com
www.marketwatch.com
www.Mattel.com
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www.nytimes.com
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www.politiken.dk
www.rankingthebrands.com
84
http://www.reuters.com/
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www.usatoday.com
www.worldbank.com
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Euromonitor
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Thomsen One Banker
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Annual reports 2006-2011, LEGO
Annual reports 2006-2011, Hasbro
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85
Euromonitor, (2012) “Toys and game: Licensing trends”
Appendices
Appendix 1
LEGO Values
The LEGO® Brand values
Imagination:
Curiosity asks, ”Why?” and imagines explanations or possibilities (if.. then). Playfulness asks what if? and
imagines how the ordinary becomes extraordinary, fantasy or fiction. Dreaming it is a first step towards
doing it.
Free play is how children develop their imagination – the foundation for creativity
Creativity
Creativity is the ability to come up with ideas and things that are new, surprising and valuable. Systematic
creativity is a particular form of creativity that combines logic and reasoning with playfulness and
imagination.
Fun
Fun is the happiness we experience when we are fully engaged in something that requires mastery (hard fun),
when our abilities are in balance with the challenge at hand and we are making progress towards a goal. Fun
is both in the process, and in the completion.
Fun is being active together, the thrill of an adventure, the joyful enthusiasm of children and the delight in
surprising both yourself and others in what you can do or create.
Learning
Learning is about opportunities to experiment, improvise and discover – expanding our thinking and doing
(hands-on, minds-on), helping us see and appreciate multiple perspectives.
Caring
Caring is about the desire to make a positive difference in the lives of children, for our partners, colleagues
and the world we find ourselves in, and considering their perspective in everything we do.
Going the extra mile for other people, not because we have to – but because it feels right and because we
care.
Caring is about humility – not thinking less of ourselves, but thinking of ourselves less.
Quality
From a reputation for manufacturing excellence to becoming trusted by all – we believe in quality that
speaks for itself and earns us the recommendation of all.
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For us quality means the challenge of continuous improvement to be the best toy, the best for children and
their development and the best to our community and partners.
Appendix 2
LEGO
Millions DKK 2006 2007 2008 2009 2010 2011

Equity primo 563 1.191 1.679 2.066 3.291 5.473
Minority interests (MIN) 4 7 8 8 15 21
Equity primo, excl MIN 559 1.184 1.671 2.058 3.276 5.452
Transactions with owners

Dividends paid to shareholders -500 -400 -1.000 -1.000 -1.500 -2.500
Total -500 -400 -1.000 -1.000 -1.500 -2.500
Total income minus non-controlling interests

Profit for the year 1.290 1.028 1.352 2.204 3.718 4.160
Cash flow hedges 31 -2 37 0 -201 -184
Tax on cash flow hedges -8 1 -10 0 38 46
Currency translation differences -184 -135 17 21 143 -2
Dirty surplus, total -161 -136 44 21 -20 -140
Minority interests 4 5 9 7 22 23
Total comprehensive income, excl MIN 1.125 887 1.387 2.218 3.676 3.997
Total changes in equity 625 487 387 1.218 2.176 1.497

Equity ultimo 1.184 1.671 2.058 3.276 5.452 6.949
Mattel
Thousands USD 2006 2007 2008 2009 2010 2011

2.101.73 2.432.97 2.306.74 2.117.13 2.530.98 2.628.58
Equity primo 3 4 2 5 9 4
Transactions with owners 0 0 0 0 0 0

Dividends paid to shareholders -249.542 -272.343 -268.854 -271.353 -291.256 -316.503
Other adjustments -54.143 0 0 0 -8.700 0
Purchase of treasury stock -192.749 -806.349 -90.570 0 -446.704 -536.318
Issuance of stock for option exercises 119.374 220.072 18.119 30.896 73.364 115.611
Other issuance of treasury stock 50 65 150 0 100 0
Restricted stock units 0 -9 -5.348 -8.092 -10.547 -36.101
87
Deferred compensation 0 6.046 1.414 -995 4.814 150
Share based compensation 27.546 21.870 35.639 49.962 67.138 53.476
Tax benefit 8.522 5.706 -2.303 36.726 7.530 24.199
Dividends equivalent for restricted stock
units -1.054 -2.334 -2.665 -3.095 -3.342 -3.557
Total transactions with owners -341.996 -827.276 -314.418 -165.951 -607.603 -699.043
Total income
Derivative instruments, net of tax -10.787 -13.918 25.388 -19.805 11.749 27.743
Defined benefit pension plans, net of tax 21.465 28.316 -87.636 18.696 7.703 -38.084
Currency translation adjustments 69.632 86.653 -192.577 52.210 883 -77.105
Dirty surplus, total 80.310 101.051 -254.825 51.101 20.335 -87.446
Total comprehensive income, excl MIN 673.237 701.044 124.811 579.805 705.198 681.062
Total changes in equity 331.241 -126.232 -189.607 413.854 97.595 -17.981

2.432.97 2.306.74 2.117.13 2.530.98 2.628.58 2.610.60
Equity ultimo 4 2 5 9 4 3
Hasbro
Thousands USD 2006 2007 2008 2009 2010 2011

1.723.47 1.537.89 1.385.09 1.390.78 1.594.77 1.615.42
Equity primo 6 0 2 6 2 0
Dividends paid to shareholders -78.714 -98.005 -111.677 -111.031 -139.984 -158.264

Other adjustments -26.750 13.994 0 0 0 0
Share based compensation transactions 101.147 99.671 145.655 4.794 109.224 29.629
Conversion of debentures 0 168 0 0 307.427 0
Purchase of common stock -456.744 -587.004 -357.589 -90.994 -636.681 -423.008
Share based compensation expense 22.832 29.402 35.221 29.912 33.392 12.463
Total income -438.229 -541.774 -288.390 -167.319 -326.622 -539.180
Total income
Derivative instruments, net of tax 0 0 0 -42.452 -4.978 -5.351
Defined benefit pension plans, net of
tax 0 0 0 15.045 -13.047 -16.897
Currency translation adjustments 0 0 0 23.782 -32.457 -21.844
Dirty surplus, total 22.588 55.973 -12.682 -3.625 -50.482 -44.092
Total changes in equity -185.586 -152.798 5.694 203.986 20.648 -197.905
Total changes in equity -185.586 -152.798 5.694 203.986 20.648 -197.905
88
1.537.89 1.385.09 1.390.78 1.594.77 1.615.42 1.417.51
Equity ultimo 0 2 6 2 0 5
Appendix 3
LEGO
Millions DKK 2006 2007 2008 2009 2010 2011

Operating current assets
Current assets 0 0 0 0 0 0
Deferred tax assets 388 281 132 94 180 114
Non-current assets held for sale 303 42 0 0 0 0
Inventories 930 946 870 1.056 1.327 1.541
Trade receivables 1.824 1.796 1.822 2.128 3.321 3.845
Other receivables 421 681 439 604 584 603
Prepayments 0 0 0 0 34 462
Current tax receivables 71 71 130 111 12 244
Operational cash 156 161 191 233 320 375
Total operating current assets 4.093 3.978 3.584 4.226 5.778 7.184
Operating current liabilities

Trade payables 749 778 1.036 1.336 1.518 1.611
Current tax liabilities 108 121 83 94 297 97
Other short-term debt 518 566 649 679 780 916
Total operating current liabilities 1.375 1.465 1.768 2.109 2.595 2.624
Net Working capital 2.718 2.513 1.816 2.117 3.183 4.560
Operating non-current assets

Intangible assets 0 34 105 232 185 190
Add: Capitalized Operating Leases 878 1.246 1.278 1.718 2.057 1.939
Land, buildings and installations 705 543 549 699 863 1.140
Plant and machinery 358 431 500 766 983 1.239
Other fixtures and fittings, tools and equipment 97 126 139 246 384 502
Fixed assets under construction 38 54 78 219 338 514
Total non-current operating assets 2.076 2.434 2.649 3.880 4.810 5.524
Non-current operating liabilities

Deferred tax liabilities 127 128 98 82 21 50
Pension obligations 62 63 50 56 52 55
Provisions 391 267 201 120 78 106
Total non-current operating liabilities 580 458 349 258 151 211
Net non-current operating assets 1.496 1.976 2.300 3.622 4.659 5.313
89
Invested Capital 4214 4489 4115 5739 7842 9873
Financial assets
Remaining Cash and cash equivalents 1.541 840 938 1.397 482 182
Marketable securities 75 0 0 0 0 0
Investments in associates 0 3 3 3 3 3
Receivables from related parties 0 0 600 0 1.956 1.950
Total financial assets 1.616 843 1.541 1.400 2.441 2.135
Financial liabilities
Subordinate loan capital 1.100 1.100 500 0 0 0
Debt regarding group restructuring 1.288 0 0 0 0 0
Borrowing 380 314 843 837 832 824
Financial leasing 87 93 86 71 62 36
Add: Capitalized Operating Leases 878 1.246 1.278 1.718 2.057 1.939
Debt to related parties 222 123 127 183 209 242
Other short term liabilities 684 777 757 1.039 1.650 1.992
Total financial liabilities 4.639 3.653 3.591 3.848 4.810 5.033

Net financial assets -3.023 -2.810 -2.049 -2.448 -2.369 -2.898
Common shareholders’ equity 1.191 1.679 2.066 3.291 5.473 6.975
Millions DKK 2006 2007 2008 2009 2010 2011

Cash and cash equivalents 1697 1001 1129 1630 802 557
Operating cash (2% of sales) 155,96 160,54 190,52 233,22 320,28 374,62
Excess Cash 1541,04 840,46 938,48 1396,78 481,72 182,38
Millions DKK 2006 2007 2008 2009 2010 2011

Operating lease expense 143 131 194 188 248 285
Cost of debt 0,0574 0,0639 0,0554 0,05265 0,0468 0,05523
Asset life 10,9 10,9 10,9 10,9 10,9 10,9
Asset value 878,351 1246,44 1277,67 1717,53 2057,12 1939,13
Operating interest expense 56,12663 69,05284 67,2692 80,38056 113,6148
Depreciation 80,58266 114,3524 117,2172 157,5719 188,7267
Mattel
Thousands USD 2006 2007 2008 2009 2010 2011

90
Operating Cash 113.003 119.402 118.360 108.617 117.124 125.321
Accounts receivable 943.813 991.196 873.542 749.335 1.146.106 1.246.687
Inventories 383.149 428.710 485.925 355.663 463.838 487.000
Prepaid expenses and other current
assets 317.624 271.882 409.689 332.624 335.543 340.907
Total operating current assets 1.757.589 1.811.190 1.887.516 1.546.239 2.062.611 2.199.915

Income taxes payable 161.917 17.072 38.855 40.368 51.801 27.110
Accounts payable 375.882 441.145 421.736 350.675 406.270 334.999
Accrued liabilities 980.435 713.209 649.383 617.881 642.211 618.801
Short term debt 64.286 50.000 150.000 50.000 250.000 50.000
Total operating current liabilities 1.582.520 1.221.426 1.259.974 1.058.924 1.350.282 1.030.910
Net Working capital 175.069 589.764 627.542 487.315 712.329 1.169.005

Property, plant and equipment, net 536.749 518.616 536.162 504.808 484.705 523.941
Goodwill 845.324 845.649 815.803 828.468 824.007 822.139
Add: Capitalized operating leases 623.562 676.548 828.445 815.828 817.796 770.889
Other non-current assets 723.673 848.254 936.224 892.660 882.411 881.851
Total non-current operating assets 2.729.308 2.889.067 3.116.634 3.041.764 3.008.919 2.998.820
Non-current operating liabilities

Benefit plan 176.584 149.045 286.557 255.234 257.195 278.354
Total non-current operating liabilities 176.584 149.045 286.557 255.234 257.195 278.354
Net non-current operating assets 2.552.724 2.740.022 2.830.077 2.786.530 2.751.724 2.720.466
Financial assets
Excess cash 1.092.549 781.746 499.334 1.008.380 1.163.999 1.243.792
Total financial assets 1.092.549 781.746 499.334 1.008.380 1.163.999 1.243.792
Borrowings 0 349.003 0 1.950 0 8.018
Other 119.357 108.686 128.629 124.858 118.146 139.815
Long term debt 635.714 550.000 750.000 700.000 950.000 1.500.000
Add: Capitalized operating leases 623.562 676.548 828.445 815.828 817.796 770.889
Non-current tax liabilities 8.735 120.553 132.744 108.600 113.526 103.938
91
Total financial liabilities 1.387.368 1.804.790 1.839.818 1.751.236 1.999.468 2.522.660
- -
Net financial assets -294.819 1.023.044 1.340.484 -742.856 -835.469 -1.278.868
Common shareholders’ equity 2.432.974 2.306.742 2.117.135 2.530.989 2.628.584 2.610.603
Thousands USD 2006 2007 2008 2009 2010 2011

Cash and equivalents 1.205.552 901.148 617.694 1.116.997 1.281.123 1.369.113
Operating cash (2% of sales) 113.003,1 119.401,8 118.360,0 108.616,9 117.123,9 125.320,7
1.092.548,9 781.746,2 499.334,0 1.008.380,1 1.163.999,1 1.243.792,3
Excess Cash
0 0 0 0 0 0
Thousands USD 2006 2007 2008 2009 2010 2011

Operating lease expense 86.900 93.000 105.300 121.900 117.800 113.300
Cost of debt 5,70% 6,40% 5,50% 5,30% 4,70% 5,50%
Asset life 10,9 10,9 10,9 10,9 10,9 10,9
Asset value 623.562 676.548 828.445 815.828 817.796 770.889
Operating interest expense 39.846 37.481 43.618 38.181 45.167
Depreciation 57.208 62.069 76.004 74.847 75.027
Hasbro
Thousands USD 2006 2007 2008 2009 2010 2011

Operating Cash 63.030 77.151 80.430 81.359 80.043 85.712
Receivables 556.287 654.789 611.766 1.038.802 961.252 1.034.580
Inventories 203.337 259.081 300.463 207.895 364.194 333.993
Prepaid 243.291 199.912 171.387 162.290 167.807 243.431
Total operating current assets 1.065.945 1.190.933 1.164.046 1.490.346 1.573.296 1.697.716

Account payable 160.015 186.202 184.453 173.388 132.517 134.864
Accrued liabilities 735.296 555.920 607.853 628.387 571.716 627.050
Current portion of long -term debt 0 135.348 0 0 0 0
Total operating current liabilities 895.311 877.470 792.306 801.775 704.233 761.914
Net Working capital 170.634 313.463 371.740 688.571 869.063 935.802
92
Property, plant and equipment 181.726 187.960 211.707 220.706 233.580 218.021
Add: Capitalized operating lease 247.393 292.565 292.082 281.012 318.064 318.064
Goodwill 469.938 471.177 474.497 475.931 474.813 474.792
Other 726.926 689.686 768.587 1.155.223 1.163.784 1.184.269
Total non-current operating assets 1.625.983 1.641.388 1.746.873 2.132.872 2.190.241 2.195.146
Total non-current operating liabilities 0 0 0 0 0 0
Net non-current operating assets 1.625.983 1.641.388 1.746.873 2.132.872 2.190.241 2.195.146
Financial assets
Excess cash 652.370 697.307 549.960 554.686 647.753 555.976
Total financial assets 652.370 697.307 549.960 554.686 647.753 555.976
Borrowings 10.582 10.201 7.586 14.113 14.568 180.430
Other 158.205 254.577 268.396 354.234 361.324 370.043
Long term debt 494.917 709.723 709.723 1.131.998 1.397.681 1.400.872
Add: Capitalized operating lease 247.393 292.565 292.082 281.012 318.064 318.064
Total financial liabilities 911.097 1.267.066 1.277.787 1.781.357 2.091.637 2.269.409

Net financial assets -258.727 -569.759 -727.827 ######## ######## ########
Common shareholders’ equity 1.537.890 1.385.092 1.390.786 1.594.772 1.615.420 1.417.515
Thousands USD 2006 2007 2008 2009 2010 2011

Cash and equivalents 715400 774458 630390 636045 727796 641688
Operating cash (2% of sales) 63.029,60 77.151,10 80.430,40 81.358,90 80.043,20 85.711,80
Excess Cash 652.370,40 697.306,90 549.959,60 554.686,10 647.752,80 555.976,20
Thousands USD 2006 2007 2008 2009 2010 2011

Operating lease expense 35.570 36.897 43.634 43.562 41.911 47.437
Cost of debt 5,70% 5,70% 5,70% 5,70% 5,70% 5,70%
Asset life 10,9 10,9 10,9 10,9 10,9 10,9
Asset value 247.393 292.565 292.082 281.012 318.064 318.064
Operating interest expense 14.200 16.793 16.765 16.130 18.257
Depreciation 22.697 26.841 26.797 25.781 29.180
93
Appendix 4
LEGO
Millions DKK 2006 2007 2008 2009 2010 2011

Operating income
Revenue 7.798 8.027 9.526 11.661 16.014 18.731
Production costs -2.632 -2.599 -2.964 -3.187 -4.066 -5.078
Restructuring costs and other special items -350 -46 116 -15 -4 0
Other operating income 141 224 0 0 0 0
Gross Profit 4.957 5.606 6.678 8.459 11.944 13.653
Operating expenses
Sales and distribution expenses -2.613 -2.768 -2.944 -3.575 -4.568 -5.132
Administrative expenses -438 -538 -604 -815 -882 -1.033
Other operating expenses -643 -598 -740 -738 -927 -1.184
Add: Operating interest expense 0 56 69 67 80 114
EBITDA 1.263 1.758 2.459 3.398 5.647 6.418
Depreciation and amortization -208 -277 -270 -344 -456 -638
Reversal of impairment of fixed assets 270 24 -20 -85 146 0
EBIT 1.325 1.505 2.169 2.969 5.337 5.780
Taxes
Taxes as reported 9 -386 -500 -683 -1.171 -1.382
Tax on financial items (Tax shield) -12 -9 -62 -4 -21 -31
Taxes total -3 -395 -562 -687 -1.192 -1.413
NOPAT 1322 1110 1607 2283 4145 4367
Financial Income
Financial income 135 123 41 131 21 34
Financial expenses -179 -158 -289 -146 -105 -158
Net financial income -44 -35 -248 -15 -84 -124
Tax effect (at 25%) -12 -9 -62 -4 -21 -31
Net financial income after tax -32 -26 -186 -11 -63 -93
Remove: Operating interest expense 0 -56 -69 -67 -80 -114
Dirty Surplus -161 -136 44 21 -20 -140
Net comprehensive Income 1.129 892 1.396 2.225 3.982 4.020
Minority Interests 4 5 9 7 22 23
Comprehensive Income, LEGO Group 1.125 887 1.387 2.218 3.960 3.997
94
Mattel
Thousands USD 2006 2007 2008 2009 2010 2011

Operating income
Net Sales 5.650.156 5.970.090 5.918.002 5.430.846 5.856.195 6.266.037
- - - - - -
Cost of sales 2.932.010 3.087.940 3.130.087 2.617.997 2.804.125 3.103.312
Gross Profit 2.718.146 2.882.150 2.787.915 2.812.849 3.052.070 3.162.725
Operating expenses
Advertising and promotion -628.189 -685.492 -696.138 -587.719 -625.607 -695.460
Add: Operating interest expense 0 39.846 37.481 43.618 38.181 45.167
- - - - - -
Other selling and administration 1.188.876 1.294.500 1.377.890 1.324.133 1.358.752 1.397.866
EBITDA 901.082 942.004 751.368 944.616 1.105.891 1.114.566
Depreciation and amortization -172.264 -172.080 -172.095 -169.830 -165.808 -28.298
EBIT 728.818 769.924 579.273 774.786 940.083 1.086.268
Taxes
Taxes as reported -90.829 -103.405 -108.328 -131.343 -161.962 -202.165
Tax on financial items (Tax
shield) -15.772 -9.338 -18.840 -24.889 -19.277 -24.650
Taxes total -106.601 -112.743 -127.168 -156.232 -181.239 -226.815
NOPAT 622217 657181 452105 618554 758844 859453
Financial Income
Financial income 34.791 44.294 28.116 8.093 9.762 8.093
Financial expenses -79.853 -70.974 -81.944 -79.204 -64.839 -78.521
Net financial income -45.062 -26.680 -53.828 -71.111 -55.077 -70.428
Tax effect (at 35%) 15.772 9.338 18.840 24.889 19.277 24.650
Net financial income after tax -29.290 -17.342 -34.988 -46.222 -35.800 -45.778
Remove: Operating interest
expense 0 -39.846 -37.481 -43.618 -38.181 -45.167
Dirty Surplus 80.310 101.051 -254.825 51.101 20.335 -87.446
Net comprehensive Income 673.237 701.044 124.811 579.815 705.198 681.062
Hasbro
Thousands USD 2006 2007 2008 2009 2010 2011

Operating income
Net Sales 3.151.481 3.857.557 4.021.520 4.067.947 4.002.161 4.285.589
95
- - - - - -
Cost of sales 1.271.110 1.533.547 1.649.600 1.628.958 1.641.545 1.778.353
Gross Profit 1.880.371 2.324.010 2.371.920 2.438.989 2.360.616 2.507.236
Operating expenses
Royalties -165.465 -308.152 -305.012 -321.306 -241.435 -328.519
Research and product development -167.051 -162.626 -186.547 -176.074 -195.578 -191.405
Advertising -359.721 -422.865 -443.029 -400.919 -408.576 -400.896
Selling, distribution and
administration -665.065 -734.497 -776.898 -771.130 -758.768 -796.168
Add: Operating interest expense 0 14.200 16.793 16.765 16.130 18.257
EBITDA 523.070 710.070 677.227 786.326 772.388 808.504
Depreciation and amortization -146.707 -156.520 -166.138 -180.963 -168.399 -196.266
EBIT 376.363 553.550 511.089 605.363 603.989 612.238
Taxes
Taxes as reported -111.419 -129.379 -134.289 -154.767 -109.968 -101.026
Tax on financial items (Tax shield) -12.211 -19.939 -18.634 -20.615 -28.049 -37.656
Taxes total -123.630 -149.318 -152.923 -175.382 -138.017 -138.682
NOPAT 252733 404233 358166 429981 465972 473556
Financial Income
Financial income 27.609 29.973 17.654 2.858 5.649 6.834
Financial expenses -62.498 -86.941 -70.895 -61.759 -85.788 -114.422
Net financial income -34.889 -56.968 -53.241 -58.901 -80.139 -107.588
Tax effect (at 35%) 12.211 19.939 18.634 20.615 28.049 37.656
Net financial income after tax -22.678 -37.029 -34.607 -38.286 -52.090 -69.932
Remove: Operating interest expense 0 -14.200 -16.793 -16.765 -16.130 -18.257
Dirty Surplus 22.588 55.973 -12.682 -3.625 -50.482 -44.092
Net comprehensive Income 252.643 408.976 294.084 371.305 347.270 341.275
96
Appendix 5
Return on ten-year zero coupon

6%
5%
4%
3%
2% Return
1%
0%
2004M11
2005M03
2005M07
2005M11
2006M03
2006M07
2006M11
2007M03
2007M07
2007M11
2008M03
2008M07
2008M11
2009M03
2009M07
2009M11
2010M03
2010M07
2010M11
2011M03
2011M07
2011M11
2012M03
2012M07
2012M11
Appendix 6
Date Hasbro Mattel Nasdaq Hasbro2 Mattel2 Nasdaq2 Beta Hasbro Beta Mattel
Dec 1, 2011 30,1 26,3 2605,2 -0,11 -0,04 -0,01 0,83609 0,75198
Nov 1, 2011 33,8 27,3 2620,3 -0,06 0,03 -0,02
Oct 3, 2011 36 26,6 2684,4 0,18 0,09 0,11
Sep 1, 2011 30,6 24,3 2415,4 -0,16 -0,04 -0,06
Aug 1, 2011 36,3 25,3 2579,5 -0,02 0,02 -0,06
Jul 1, 2011 37,1 24,8 2756,4 -0,09 -0,03 -0,01
Jun 1, 2011 40,9 25,6 2773,5 -0,04 0,04 -0,02
May 2, 2011 42,6 24,6 2835,3 -0,02 0 -0,01
Apr 1, 2011 43,6 24,7 2873,5 0,01 0,07 0,03
Mar 1, 2011 43,3 23 2781,1 0,04 -0,01 0
Feb 1, 2011 41,5 23,2 2782,3 0,02 0,07 0,03
Jan 3, 2011 40,8 21,7 2700,1 -0,06 -0,07 0,02
Dec 1, 2010 43,4 23,3 2652,9 -0,01 0,02 0,06
Nov 1, 2010 43,8 22,9 2498,2 0,03 0,11 0
Oct 1, 2010 42,5 20,7 2507,4 0,04 -0,01 0,06
Sep 1, 2010 40,7 20,8 2368,6 0,1 0,12 0,12
Aug 2, 2010 36,9 18,6 2114 -0,04 -0,01 -0,06
Jul 1, 2010 38,6 18,8 2254,7 0,03 0 0,07
Jun 1, 2010 37,4 18,8 2109,2 0,02 -0,02 -0,07
May 3, 2010 36,5 19,2 2257 0,05 -0,06 -0,08
97
Apr 1, 2010 34,9 20,4 2461,2 0,01 0,01 0,03
Mar 1, 2010 34,6 20,1 2398 0,07 0,03 0,07
Feb 1, 2010 32,3 19,5 2238,3 0,17 0,12 0,04
Jan 4, 2010 27,6 17,5 2147,4 -0,04 -0,01 -0,05
Dec 1, 2009 28,8 17,7 2269,2 0,08 0,03 0,06
Nov 2, 2009 26,6 17,2 2144,6 0,09 0,07 0,05
Oct 1, 2009 24,5 16,2 2045,1 -0,01 0,03 -0,04
Sep 1, 2009 24,7 15,8 2122,4 -0,02 0,03 0,06
Aug 3, 2009 25,3 15,4 2009,1 0,07 0,02 0,02
Jul 1, 2009 23,6 15 1978,5 0,1 0,09 0,08
Jun 1, 2009 21,4 13,7 1835 -0,05 0,03 0,03
May 1, 2009 22,5 13,3 1774,3 -0,05 0,04 0,03
Apr 1, 2009 23,6 12,8 1717,3 0,07 0,3 0,12
Mar 2, 2009 22 9,8 1528,6 0,1 -0,03 0,11
Feb 2, 2009 20,1 10,1 1377,8 -0,05 -0,17 -0,07
Jan 2, 2009 21,2 12,1 1476,4 -0,17 -0,11 -0,06
Dec 1, 2008 25,4 13,7 1577 0,09 0,24 0,03
Nov 3, 2008 23,3 11 1535,6 -0,08 -0,09 -0,11
Oct 1, 2008 25,3 12,1 1721 -0,16 -0,17 -0,18
Sep 2, 2008 30 14,5 2091,9 -0,07 -0,07 -0,12
Aug 1, 2008 32,3 15,6 2367,5 -0,03 -0,04 0,02
Jul 1, 2008 33,5 16,2 2325,6 0,09 0,17 0,01
Jun 2, 2008 30,7 13,8 2293 -0,01 -0,15 -0,09
May 1, 2008 31,2 16,2 2522,7 0,02 0,07 0,05
Apr 1, 2008 30,6 15,1 2412,8 0,28 -0,06 0,06
Mar 3, 2008 23,9 16 2279,1 0,08 0,03 0
Feb 1, 2008 22,1 15,6 2271,5 -0,01 -0,08 -0,05
Jan 2, 2008 22,2 16,9 2389,9 0,02 0,1 -0,1
Dec 3, 2007 21,7 15,3 2652,3 -0,08 -0,05 0
Nov 1, 2007 23,6 16,1 2661 -0,07 -0,01 -0,07
Oct 1, 2007 25,4 16,2 2859,1 0,08 -0,11 0,06
Sep 4, 2007 23,6 18,2 2701,5 -0,01 0,09 0,04
Aug 1, 2007 23,9 16,8 2596,4 0,01 -0,06 0,02
Jul 2, 2007 23,7 17,8 2546,3 -0,1 -0,09 -0,02
Jun 1, 2007 26,4 19,7 2603,2 -0,02 -0,1 0
May 1, 2007 27 21,8 2604,5 0,02 -0,01 0,03
Apr 2, 2007 26,6 22 2525,1 0,11 0,03 0,04
Mar 1, 2007 23,9 21,4 2421,6 0,01 0,06 0
Feb 1, 2007 23,6 20,2 2416,2 0 0,07 -0,02
Jan 3, 2007 23,8 18,9 2463,9 0,05 0,08 0,02
Dec 29, 2006 22,7 17,6 2415,3
98
Appendix 7
Forecasted
In % Income Statement 2012E 2013E 2012E 2014E2013E2015E 2014E 2016E 2017E 2017E
2015E 2016E 2018E 2018E 2019E2019E2020E 2020E 2021E Terminal
2021E Terminal
Sales
Sales growth
growth 23.039,1 27.647,023,0% 32.346,9
20,0%37.522,4
17,0% 42.775,6
16,0% 47.908,7
14,0% 12,0% 52.699,510,0%
57.969,5
10,0%63.186,79,0% 67.609,8
7,0% 69.638,1
3,0%
Cost as percentage of revenue
Cost as percentage of revenue
Production costs -6.390,2 -7.783,3 -9.243,1 -10.882,8 -12.592,5 -14.315,1 -15.982,8 -17.844,8 -19.742,6 -21.441,5 -23.677,0
Production
Gross profit costs 16.648,9 19.863,7 -27,7% -28,2%26.639,7
23.103,9 -28,6% 30.183,1
-29,0% -29,4%
33.593,6 -29,9% -30,3%
36.716,7 -30,8%43.444,1
40.124,7 -31,2% 46.168,3
-31,7% -34,0%
45.961,1
Sales and
Gross distribution expenses
profit -6.220,6 -7.576,672,3%
-8.997,6
71,8%-10.593,8
71,4% -12.258,1
71,0% -13.935,0
70,6% 70,1%-15.558,569,7%
-17.371,0
69,2%-19.218,4
68,8% -20.872,2
68,3% -22.284,2
66,0%
Administrative expenses -1.267,2 -1.543,4 -1.832,9 -2.158,0 -2.497,0 -2.838,6 -3.169,3 -3.538,5 -3.914,9 -4.251,7 -4.874,7
Sales and distribution expenses -27,0% -27,4% -27,8% -28,2% -28,7% -29,1% -29,5% -30,0% -30,4% -30,9% -32,0%
Other operating expenses -1.382,3 -1.683,7 -1.999,5 -2.354,2 -2.724,0 -3.096,7 -3.457,4 -3.860,2 -4.270,8 -4.638,3 -5.222,9
Administrative
Add: Operatingexpenses
interest expense 100,0 150,2-5,5% 180,2-5,6% 210,9
-5,7% -5,8%
244,6 -5,8%
278,8 -5,9%312,3-6,0% 343,5-6,1% 377,9-6,2% -6,3%
411,9 -7,0%
440,7
EBITDA
Other operating expenses 7.878,8 9.210,1-6,0% -6,1%11.744,5
10.454,1 -6,2% 12.948,5
-6,3% 14.002,1
-6,4% -6,5%
14.843,8-6,6% -6,7%16.417,9
15.698,4 -6,8% 16.818,0
-6,9% -7,5%
14.020,1
Depreciation and amortization
Add: Operating interest expense -691,2 -857,1 -1.002,8
0,4% 0,5%-1.200,7
0,6% -1.389,4
0,6% -1.579,4
0,6% -1.763,4
0,6% -1.968,9
0,6% 0,6% -2.178,2
0,6% -2.365,7
0,6% -2.437,3
0,6%
EBIT 7.187,6 8.353,0 9.451,4 10.543,8 11.559,2 12.422,6 13.080,4 13.729,5 14.239,7 14.452,4 11.582,8
EBITDA 34,2% 33,3% 32,3% 31,3% 30,3% 29,2% 28,2% 27,1% 26,0% 24,9% 20,1%
Taxes -1.796,9 -2.088,3 -2.362,8 -2.635,9 -2.889,8 -3.105,7 -3.270,1 -3.432,4 -3.559,9 -3.613,1 -2.895,7
Depreciation
NOPAT and amortization 5.390,7 6.264,8-3,0% -3,1% 7.907,8
7.088,5 -3,1% 8.669,4
-3,2% -3,2%
9.317,0 -3,3%
9.810,3-3,3% -3,4%10.679,8
10.297,1 -3,4% 10.839,3
-3,5% -3,5%
8.687,1
EBIT 31,2% 30,2% 29,2% 28,1% 27,0% 25,9% 24,8% 23,7% 22,5% 21,4% 16,6%
Taxes 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0% 25,0%
Profit margin 23,4% 22,7% 21,9% 21,1% 20,3% 19,4% 18,6% 17,8% 16,9% 16,0% 12,5%
Appendix 8
Forecasted balance items to sales ratio 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Current assets
Deferred tax assets 0,05 0,04 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01
Non-current assets held for sale 0,04 0,01 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00
Inventories 0,12 0,12 0,09 0,09 0,08 0,08 0,09 0,09 0,09 0,09 0,09 0,09 0,09 0,09 0,09 0,09
Trade receivables 0,23 0,22 0,19 0,18 0,21 0,21 0,20 0,20 0,20 0,20 0,20 0,20 0,20 0,20 0,20 0,20
Other receivables 0,05 0,08 0,05 0,05 0,04 0,03 0,04 0,04 0,04 0,04 0,04 0,04 0,04 0,04 0,04 0,04
Prepayments 0,00 0,00 0,00 0,00 0,00 0,02 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01
Current tax receivables 0,01 0,01 0,01 0,01 0,00 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01
Operational cash 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02
99
Total operating current assets 0,52 0,50 0,38 0,36 0,36 0,38 0,37 0,37 0,37 0,37 0,37 0,37 0,37 0,37 0,37 0,37
Trade payables 0,10 0,10 0,11 0,11 0,09 0,09 0,10 0,10 0,10 0,10 0,10 0,10 0,10 0,10 0,10 0,10
Current tax liabilities 0,01 0,02 0,01 0,01 0,02 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01
Other short-term debt 0,07 0,07 0,07 0,06 0,05 0,05 0,05 0,05 0,05 0,05 0,05 0,05 0,05 0,05 0,05 0,05
Total operating current liabilities 0,18 0,18 0,19 0,18 0,16 0,14 0,16 0,16 0,16 0,16 0,16 0,16 0,16 0,16 0,16 0,16
Net Working capital 0,35 0,31 0,19 0,18 0,20 0,24 0,21 0,21 0,21 0,21 0,21 0,21 0,21 0,21 0,21 0,21
Intangible assets 0,00 0,00 0,01 0,02 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01
Add: Capitalized Operating Leases 0,11 0,16 0,13 0,15 0,13 0,10 0,13 0,13 0,13 0,13 0,13 0,13 0,13 0,13 0,13 0,13
Land, buildings and installations 0,09 0,07 0,06 0,06 0,05 0,06 0,06 0,06 0,06 0,06 0,06 0,06 0,06 0,06 0,06 0,06
Plant and machinery 0,05 0,05 0,05 0,07 0,06 0,07 0,06 0,06 0,06 0,06 0,06 0,06 0,06 0,06 0,06 0,06
Other fixtures and fittings, tools and equipment 0,01 0,02 0,01 0,02 0,02 0,03 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02 0,02
Fixed assets under construction 0,00 0,01 0,01 0,02 0,02 0,03 0,03 0,03 0,04 0,04 0,04 0,05 0,05 0,05 0,05 0,057
Total Non-Current Operating Assets 0,27 0,30 0,28 0,33 0,30 0,29 0,32 0,32 0,32 0,33 0,33 0,33 0,34 0,34 0,34 0,34
Deferred tax liabilities 0,02 0,02 0,01 0,01 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00
Pension obligations 0,01 0,01 0,01 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00 0,00
Provisions 0,05 0,03 0,02 0,01 0,00 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01
Total Non-Current Operating Liabilities 0,07 0,06 0,04 0,02 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01 0,01
NNCOA 0,19 0,25 0,24 0,31 0,29 0,28 0,30 0,31 0,31 0,31 0,32 0,32 0,32 0,32 0,33 0,33
Invested Capital 0,54 0,56 0,43 0,49 0,49 0,53 0,51 0,51 0,52 0,52 0,52 0,53 0,53 0,53 0,53 0,54
Appendix 9
Millions DKK 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E Terminal
NOPAT 1.278 1.795 2.594 4.295 4.817 5.391 6.265 7.089 7.908 8.669 9.317 9.810 10.297 10.680 10.839 8.687
Depreciation and amortization 277 270 344 456 638 691 857 1.003 1.201 1.389 1.579 1.763 1.969 2.178 2.366 2.437
Gross cash flow 1.555 2.065 2.938 4.751 5.455 6.082 7.122 8.091 9.109 10.059 10.896 11.574 12.266 12.858 13.205 11.124
Change in operating capital -205 -697 302 1.066 1.376 231 958 977 1.076 1.092 1.067 996 1.096 1.085 920
Net capital expenditures 480 323 1.322 1.038 654 1.669 1.479 1.535 1.712 1.768 1.761 1.682 1.866 1.880 1.649 669
Gross Investment 552 -104 1.968 2.560 2.668 2.591 3.294 3.515 3.989 4.249 4.408 4.441 4.930 5.143 4.935 3.529
FCFF 1.004 2.169 971 2.191 2.787 3.491 3.827 4.576 5.120 5.810 6.489 7.132 7.336 7.715 8.270 7.596
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104

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Valuation of LEGO Group

Copenhagen Business School

1.1 Problem Discussion ................................................................................................................................. 8

2.1 History of Lego...................................................................................................................................... 14

2.4 Corporate Governance: .......................................................................................................................... 20

2.4.2 Board Composition ......................................................................................................................... 20

2.4.3 Management ................................................................................................................................... 20

2.5 Products: ................................................................................................................................................ 20

3.1 Growth Opportunity .............................................................................................................................. 25

3.1.2 American Market ............................................................................................................................ 25

3.1.3 European Market ............................................................................................................................ 26

3.1.4 Asian Market .................................................................................................................................. 26

3.2 Macro Analysis...................................................................................................................................... 27

3.3Micro Analysis ....................................................................................................................................... 32

3.4 Internal Analysis .................................................................................................................................... 38

3.4.2Intangible resources ......................................................................................................................... 40

3.5 SWOT .................................................................................................................................................... 43

3.5.3 Opportunities .................................................................................................................................. 45

3.5.4 Threats ............................................................................................................................................ 46

4. Financial Analysis ................................................................................................................................... 46

4.1 Peer Group ............................................................................................................................................. 46

4.3.2Balance Sheet .................................................................................................................................. 48

4.3.3Income Statement ............................................................................................................................ 49

4.4Profitability Analysis .............................................................................................................................. 49

4.4.2 Return from Financing Activities ................................................................................................... 51

4.5 Risk analysis .......................................................................................................................................... 55

4.5.2 Financial Risk ................................................................................................................................. 56

4.6 Part Conclusion ..................................................................................................................................... 56

5.1 Forecast Period ...................................................................................................................................... 57

5.2.2 Costs ............................................................................................................................................... 58

5.2.3 Tax Rate.......................................................................................................................................... 58

5.2.4 Unusual Items ................................................................................................................................. 59

5.2.5 NOPAT ........................................................................................................................................... 59

5.3 Balance Sheet Forecast .......................................................................................................................... 59

5.3.3 Forecasted Return on Invested Capital ........................................................................................... 61

5.4Forecasted Free Cash Flow..................................................................................................................... 62

6.1 Valuation Models .................................................................................................................................. 63

6.1.2 Economic Value Added .................................................................................................................. 64

6.2 Valuation assumptions........................................................................................................................... 64

6.3.2 Cost of debt..................................................................................................................................... 69

6.3.3 Cost of Capitalized Operating Leases............................................................................................. 69

6.3.4 Capital Structure ............................................................................................................................. 70

6.3.5 WACC ............................................................................................................................................ 70

6.4 Terminal Period ..................................................................................................................................... 71

6.7.2 Cost of Debt and Cost of Capitalized Operating Leases ................................................................ 74

6.7.3 Market Risk Premium and Terminal Growth ................................................................................. 75

6.7.4 Beta Value and Terminal Growth ................................................................................................... 76

6.7.5 Summary of sensitivity analysis ..................................................................................................... 76

6.8 Multiples Comparison ........................................................................................................................... 77

6.8.2 EV/EBITDA ................................................................................................................................... 78

6.8.3 EV/EBIT ......................................................................................................................................... 78

6.8.4 P/E .................................................................................................................................................. 78

6.8.5 Valuation of LEGO Based on Peer Ratios ..................................................................................... 79

6.8.6 Summary of Multiples Comparisons .............................................................................................. 79

Literature list: .................................................................................................................................................. 83

1.1 Problem Discussion

80.000,0 0,25 Asia Pacific

70.000,0 0,2 Eastern Europe

0,1 North America

10.000,0 -0,15 Asia Pacific

Source: Own creation, Euromonitor

1.2 Research Question

1.3 Structure of the Project

2. Presentation of LEGO Group