Description

Funko Inc. (“FNKO”)

FUNKO’s primary business is to create patented pop culture bobble heads with celebrity, video game and other licensed cultural touchstones as the selling hook. There “dolls” are primarily (90%+) sold to adult collectors – similar to PEZ. A recently botched secondary has created a compelling entry point for this unique and rapidly growing pop culture powerhouse. Like frankie3, I have owned FNKO post it’s also mishandled IPO (note to Company: please get better investment bankers to do your deals). They have one of the best CEOs of any Company that I have ever seen. Brian Mariotti is ex-military who turned his love of pop culture into a career and made his fortune several times over in the process. The numbers speak for themselves, over the last 4 years the Company has compounded Revenue and EBITDA by over 32.65% and 32.58% respectively. Management is targeting $400mm in EBITDA in the next 4-5years mostly by targeting international growth, new product lines and adding US distribution channels. They also are expanding margins by creating their first toys based on their own content (saving 15% in licensing fees). EBITDA converts mostly into FCF as it should be. While it would be great if FNKO hit those long term numbers, I believe the stock is currently worth $25-30 (where it was right before the secondary).  However, If they hit their long term growth targets, FNKO could easily be a $70-100 stock via debt pay down, cash build and cash build.

Brian Mariotti is a lifetime lover of pop culture and bought FNKO for $1mm from a friend when the business was failing back in 2005. Fast forward to today (and two leveraged recaps with different sponsors later), the Company has a publicly traded enterprise value of almost $1billion. Next year, I am forecasting about a billion of sales and $183mm of EBITDA which is a lot of bobble head tchotchkes. It is worth meeting Brian in person. He wears brightly colored sports jackets and trousers and looks the part of a pop culture CEO. Beneath a fun/cool persona is a very driven businessman.

The Company has been beating and raising its numbers nicely since its IPO which happened in the middle of the Toys R US (“TOY”) bankruptcy filing. Even though FNKO sold very little into TOY, investors dumped the stock after multiple IPO price cuts from $18 down to $12 where their private equity sponsor, Acon, declined to sell any shares. The Company also picked large cap underwriters, GS and JPM, to lead the offering instead of someone like B. Riley who would have found better holders (i.e. small cap value investors). This latest spot secondary by JPM at $25.42 was clearly put in weak hands and as 4 weeks later the stock languishes in the high teens. You are getting a lot of growth at a valuish multiple. The main reason why it has traded so cheaply is that FNKO doesn’t fit neatly into a segment (toys, media, retail?), no one really covers it on buy or sell side. I met the management team at a media conference, but they are really more of a Toy/Collectables business than anything else. There is also concern that the Pop product is a fad that will fade away. The steady climb in sales and spread from a mostly male customer base to an almost 50/50 one belied the fad thesis. The child market has barely been penetrated (only 10% of sales). International should be as big as the US and it isn’t yet. FNKO is also getting into brand extensions into clothes, board games and even cereal. Perhaps the most exciting development is the purchase of an online digital streaming company that enables FNKO to develop and market its own branded product – saving the 15% license fee that they pay on average (Star Wars is closer to 20%). The Company’s goal is to get owned IP to 20% of sales which would increase EBITDA margins by 300bp. The Company has also had success with its company owned store where the full product line can be properly marketed. While, no plans exist yet to roll this out wider, there is optionality in the line of business. In addition, FNKO is just now getting into some of the mass channels like dollar stores and Wal-Mart that are logical and massive sales opportunities. 

The Company manages both its brand and channel inventory tightly. For example, they turned down a $3-5mm order for Frozen dolls from Gamestop (“GME”) because the Company was just going to dump them in a corrugated box. GME finally agreed to display the product the way FNKO wanted (standalone endcap displays with high quality construction and graphics). The Frozen order was missed, but GME is now one of FNKO’s largest customers and accessories is GME’s fastest growing category (which gives some visibility into the quarter as GME has recently reported strong collectables growth (21.2%)). Unlike video games, Fortnite POP dolls can’t be downloaded.  GME’s potential liquidation is a risk, but it is just one of many channels that FNKO sells into. A similar story happened at Walmart, where the buyer wanted to put a multimillion Star Wars order and was cutback 75% or so to keep the channel clean and increase demand via scarcity. President, Andrew Perlmutter, comes from the family that owned Toy Biz which had the Marvel toy license. He knows how to manage retail and pop culture toys. If there is any negative is that Russell Nickel, who was a very competent CFO, just resigned to pursue other opportunities. That may be the case or he may be taking the fall for the botched IPO. The UP C tax structure (where public shareholders pay the PE sponsor for tax savings from pre IPO) has made the financials unnecessarily confusing. The tax structure has played out according the latest 10q, so financials should be clean going forward. The Company also recently bought its European distribution partner, increasing margins by over 1000bp there.

Catalyst

Catalyst

Once the secondary overhang plays out, FNKO should go back to the mid to high 20s. A return to the secondary price is an almost 40% rate of return and roughly 8x next year’s EBITDA which is exactly where it trades on trailing EBITDA today.

FNKO is guilty of being terrible at IR and the capital markets, but great at running a unique and special business with patent protection. At, $4.99 and $9.99 price points, the business should be relatively recession resistant. Maybe the Company will grow into a $400mm EBITDA goliath. I would never count Brian out. Even if it doesn’t, the Company’s current EBITDA and free cash flow could make it a good dividend payer or LBO target for the third time. Acon could even be a buyer again if it dips severely enough.