For Broadcast March 26, 2008

You could be forgiven for thinking the kids market is a bloodbath after February saw Entertainment Rights chief executive Mike Heap step down to "pursue other interests" and Hit Entertainment boss Bruce Steinberg replaced to make way for a US-based executive.

But the circumstances for the two changes are quite different. For ER, an ill-fated decision to change how fast it amortises certain assets was badly received by shareholders, beginning a share price slide last year.

That turned into a rout this year after a hitch with a supplier led to lower DVD sales at Christmas 2007 and ER's share price tumbled to under 8p earlier this month, prompting potential buyers to begin circling. These are thought to include Ashby Manor, the investment vehicle owned by Blackpool entrepreneur Trevor Hemmings, which already owns a 17% stake in ER. Also in the frame is Saban Capital, owned by Haim Saban, best known for making Power Rangers a global kids property, and hedge fund Och-Ziff Capital Management Group.

Chorion owner 3i is also in the picture, not least because ER has a strong group of US characters. This makes it a good fit, especially with Chorion putting greater emphasis on its children's properties, including the new animated Famous Five for Disney. 

Takeover talk was already brewing when Heap left the company. But I don't believe he's lying around planning his spring garden. My bet is he's lining up a buyout of ER using outside investors - perhaps even Saban, Och-Ziff or Ashby Manor - to take over the beleaguered business he ran for nine years.

However, the problem for all the potential bidders is that no one seems to know how to value ER, which owns both classic UK characters such as Basil Brush and US brands including Casper the Friendly Ghost and Lassie.

Ingenious Securities' best bet is that ER is worth 30p a share, but that value would be very hard to achieve in today's public market. However, a private buyout may be hard to fund, given the sorry state of the credit markets, and a debt-funded takeover isn't any easier given ER's £105m of debt against a forecast EBITDA of only £29m.

The other element is that US market demand has softened and is likely to get softer as a result of the economic downturn - meaning DVD sales could fall, which make up a big part of ER's bottom line.

Meanwhile, trouble in Hit Entertainment's US business seems to have been the straw that broke Mr Steinberg's back. Having been appointed by Apax when the PE firm took the company private in 2005, Steinberg was replaced this month by former Nickelodeon chief executive Jeffrey Dunn, who one suspects has been told to fix the US business fast. 

I wish him luck. Hit was hammered last year when Mattel, the world's largest toy company, had to recall 20 million toys because of fears about lead paint poisoning. Hit suffered a 2 million toy recall of its own and one of its best-producing brands, Thomas the Tank Engine, became the poster child for the lead paint scare. "Toxic Thomas" cost Hit as much as 20% in its US sales last year, according to one City source.

Overall, it appears that Hit's business wasn't being transformed as fast as the PE guys wanted and the US recall was the last straw. With a typical PE annual hurdle rate of 10% (this has to be delivered to the investing funds before the PE guys take their cut) a business has to grow at between 20% to 30% a year to give PE managers a reasonable return. According to City sources, Hit has only grown 40% over the past three years in total. Whether Dunn can do better than Steinberg remains to be seen, but avoiding poisoning scares has got to be among his key priorities.