CITIC SEC: China's puzzle toy market has broad prospects, focusing on three major breakthrough themes.

CITIC SEC released a research report stating that the Chinese building block toy market is in a period of rapid growth, with demand driving advancements in craftsmanship on the supply side. The quality gap between domestic building blocks and overseas brands is rapidly narrowing; overseas leading brands are priced high, with a wide range of prices for mass-market brands. Local brands can respond to market demands faster and better than overseas brands, bringing many opportunities. The three major breakthrough themes in the Chinese building block toy market: 1) Opportunities for blue ocean in terms of category/channel/audience dimensions; 2) Differentiation of overseas and local popular IPs, combined with cost-effectiveness advantages; 3) Having a mature IP matrix, expanding the ecosystem by adding scenes, content, and scenarios. Key points from CITIC SEC: Global toy industry: With a wide range of categories, the building block toy industry leads in terms of growth rate According to Euromonitor data and calculations based on the industry, the global toy market is slowly expanding due to the rapid development of the gaming industry and the impact of declining global birth rates. The market size is expected to reach 100.9 billion US dollars by 2023, with a CAGR of +1.3% from 2014 to 2023. The building block toy market is expected to reach 21.3 billion US dollars in 2023, with a CAGR of +6.1%, accounting for 21.1% of the toy industry, up from 13.9% in 2014, supported by strong growth in interactive and IP-compatible products. Building block toy industry: Multiple product differentiation dimensions, high barriers to production, and diverse sales models Building block toys are mainly divided into standard building block systems (such as LEGO) and character building block systems (such as Bandai, BLOKS). 1) Different systems create differences in product fidelity, mobility, and part compatibility. Standardized building blocks have higher fidelity in still/scenic categories and cross-series compatibility. According to BRICK ARCHITECT data, commonly used parts CR50 accounted for 47% of LEGO sets from 2020 to 2024, showing strong economies of scale. 2) The industry has production barriers. Overseas giants usually have their own factories, while domestic players establish supply chain layouts through self-built or outsourced production depending on the stage of development. 3) LEGO has a comprehensive channel layout, while other brands still focus on offline sales through distribution/retail channels. In 2023, LEGO's proportion of online/retail store/third-party channel revenue is 40%/35%/25%. Bandai focuses on distribution channels and has been strengthening retail store construction in recent years, with a total of 23 high base facilities worldwide. Competitive landscape: High concentration in the global building block toy industry, with a dominant leader and deep barriers According to Euromonitor data and calculations based on the industry, the industry's CR3 in 2023 is 84%, with LEGO holding a 75% share, a +6.7 percentage point increase from 2014. LEGO continues to dominate the market even after its patents expire due to its strong barriers to entry. 1) Brand end: Leading brands dominate the high-end brand mind share, squeezing profit margins through differentiation competition among mass-market brands. In 2003, MegaBloks, a major competitor, had a gross profit margin of 47%, 10 percentage points lower than LEGO. 2) Product end: 1) Thematic: Leading products cover a wide range of themes. LEGO has a total of 163 themes, while competitors have only about 10 themes with high overlap. 2) IP: Original/licensed IP drives growth, with IP-based sets commanding about a 19% premium. By 2024, LEGO's IP-based sets accounted for 59%, with a continuous increase in the proportion of IP-based sets, driving the company's gross profit margin from 57% in 2003 to 68% in 2023. 3) Ecosystem end: 1) Content ecosystem: Enhancing interactive experiences through parks and expanding IP content around film and television works. 2) User ecosystem: Creating an educational ecosystem for children; tapping into the value of AFOL through co-creation, second-hand trading, and community ecosystems. The future of the Chinese building block toy market is promising, with local brands in a window of breakthrough 1) Market space: According to Frost & Sullivan (quoted from the BLOKS prospectus), the CAGR of the toy market/building block category in China from 2023 to 2028 is +9.5%/+22.1%, leading in growth globally. Per capita toy consumption in China in 2023 is only 23.5% of Japan's and 11.9% of the US, with ample room for improvement. 2) Competitive landscape: Based on Euromonitor data and calculations from the industry, LEGO's market share in China is expected to decrease by -8.5 percentage points in 2023, with local brands accelerating their breakthroughs. 1) Production end: Strong demand is driving advancements in craftsmanship on the supply side, narrowing the quality gap of building blocks. 2) Brand end: LEGO has high pricing: the average selling price of 8 popular sets in China is 8% higher than in the US and 34% higher than in Japan; the core price reached 435 yuan in 2024, with a CAGR of +6.6% from 2021 to 2024, continuously increasing. Bandai has a narrow audience: positioned in the high-end of the industry; with age restrictions and a clear label (mostly for anime and mecha enthusiasts), it has a low overlap with the audience of domestic building block brands. The Chinese building block toy industry has three main breakthrough themes Theme One: Blue ocean opportunities inherent in category/channel/audience dimensions. 1) Category: The character building block toy segment is a blue ocean track. LEGO's limited building block particle performance and lower fidelity in character-based products account for only 15% of the segment in 2023, while Bandai only focuses on its own Gundam IP, which holds 20% of the segment in 2023. 2) Channels: Breakthroughs can be achieved through fast-selling/fine-tuned operational models. LEGO expands its presence in first/second-tier markets through retail stores, while Bandai lacks fine operational capabilities. 3) Audience: Based on cost-effectiveness, there is a market gap for children under 16 years old. Theme Two: Focus on Chinese original IPs and popular overseas IPs. According to Frost & Sullivan (quoted from the BLOKS prospectus), the Chinese IP toy market is expected to double in size from 2023 to 2028, with LEGO lacking flexibility in IP cooperation and localization design dimensions. With the increasing confidence in national culture and interest in consumption waves, focusing on Chinese original IPs and popular overseas themes brings growth opportunities. If you would like to read more translations or have any other requests, feel free to ask.The efficient/flexible products of foreign IPs are poised to break through and achieve success for local building block brands.Main line three: Using IP as the axis, through integrating building block categories with scenes, adding content, and expanding the ecosystem. Some companies have a mature IP matrix and have achieved success in specific trendy toy categories, expanding the ecosystem through building block and other categories. Risk factors: Building block toys are optional consumer goods, with risks influenced greatly by residents' purchasing power and consumption willingness; intensifying industry competition risk; intellectual property risk; commercializing authorized IP not meeting expectations risk; external competition risk.