Description

Hasbro is a good business undergoing several positive changes that should improve long-term profitability. The changes will simply the business structure, deleverage the balance sheet, and allow the company to focus on its most impactful and strategic lines of business. These changes are taking place against a depressed backdrop for the toy industry and discretionary stocks. Similarly, there have been several Hasbro specific conflicts/changes that have added to the overhang and uncertainty: an activist battle, a new CEO who has faced skepticism, an uproar among the Dungeons and Dragons and the Magic the Gathering communities, respectively, in response to Hasbro’s management of those brands, and the departure of the CFO.

I think the confluence and micro and macro events will dissipate and over the next few years, Hasbro will emerge a leaner, less leveraged, more profitable company trading at a cheap valuation on 2025 numbers.  The collection of iconic and irreplaceable branded entertainment properties including Peppa Pig, Transformers, Monopoly, Clue, Play-Doh, My Little Pony, Dungeons and Dragons, Magic the Gathering, Power Rangers, G.I. Joe, and Nerf, among others, provides some downside support as this one of the largest and most valuable collections of branded IP in the market— transactions across owned IP/rights in IP suggest that Hasbro would have a lot of value to a strategic buyer, or that Hasbro could sell or spin some of its IP.

Hasbro is toy and entertainment company with several favorable business qualities: broad consumer awareness of its brands, emotional connection with passionate fans, broad distribution, and decades of game play that familiarize customers with the rules of its games. These assets cannot be easily replicated. The toy industry is historically fickle, unpredictable, and susceptible to competition from within and outside the history. Still, Hasbro has been around for nearly 60 years proving its longevity. I think buying the stock when times are bad, and especially before several positive structural changes take place, offers a good risk/reward. I am not sure that this is a good long-term hold (maybe)—but I do see a path for the stock to re-rate close to historical multiples over the next three years providing between 80-130% upside.

            A high-level overview of the relevant history. In 2019, Hasbro paid $4B to acquire eOne,  a production studio with a portfolio of owned family brands (Peppa Pig/PJ Masks) that produced television and movies across scripted and non-scripted entertainment. The eOne deal was a marker of the strategy of Brian Goldner, the previous CEO who wanted Hasbro to have a bigger business producing (and controlling) movies and television based on its portfolio of IP. eOne was a deal done with a lot of debt before covid. Producing expensive entertainment introduced capital intensity and operating costs into the business, and created misalignment between revenue and costs given that entertainment production is capital intensive upfront with paybacks that may occur over many years (if at all). The marketing benefit of a great movie to drive toy sales is more aligned.

            Mr. Goldner died in 2021. Chris Cocks, a Hasbro gaming executive, replaced him. Under Mr. Cocks, Hasbro decided to sell a substantial piece of eOne (retaining the family brands and potentially some production capabilities). The sale of eOne is said be garnerning interest form several studios and should be completed this year. While hard to predict, the sale of eOne could net Hasbro between 500m-$1B net after tax, which will be used to pay down debt. The sale should also have the benefit of simplifying Hasbro’s financials by eliminating/reducing the amortization of film and content spend and better aligning revenue and cost.

            There are a few other key initiatives underway to simply the business. First, Hasbro has chosen to license a few of its non-core properties, essentially moving to a royalty model. Fore example, Playskoool ( preschool brand), Littlest Pet Shop will move to partial or full license model in 2024.

            Second, Hasbro has communicated plans to reduce costs at 250-$300mm run-rate by 2025.

Lastly, I believe several negative headlines surrounding the business and the new CEO will abate over the next year, improving sentiment. Among them, Alta Fox, an activist fund waged and lost a long campaign pushing Hasbro to spin-off its Wizards of the Coast division, its high-margin gaming business segment that contains Magic the Gathering and Dungeons and Dragons. I believe the Alta Fox campaign damaged public perception of the Hasbro board (some deserved) and probably created some turnover in the stock.

            Second, Hasbro faced a barrage of bad news and criticism from analysts, investors and customers over the handling of key issues with its key gaming franchises. With Magic the Gathering, customers and collectors believed that Hasbro was overproducing card sets that were damaging the resale value of the products, a key driver of collectability. There was a very damaging sell-side report in late 2022 detailing this risk.  

With Dungeons and Dragons, there was an uproar over proposed changes that Hasbro was making to OGL, or the original game license, which was going to impact how fans and small businesses were going to be able to access and monetize the trademark. Lastly, the CFO, who has been with the company announced she is going to leave.

            I believe that Hasbro has constructively responded to these missteps, is rebuilding trust with its fans and game player communities. Also, I believe that the new CEO is doing a good job communicating his vision for the business and taking meaningful strategic steps to improve profitability.

            From 2018-2021, the business generated EBITDA of $750m, $842m, $990m, $1.1B, respectively. Due to film and tv accounting as well as amortization of goodwill and intangibles, partially related to the acquisition of the Power Rangers for $522m in 2018, a big premium to tangible asset value, D&A/Amortization of goodwill and tangibles has ranged between 30-100% of net income in the last few years. Prior to 2022, Hasbro has good history of strong operating and free cash flow generation. In 2020, 2021, Hasbro generated $976m and $817m of operating cash flow respectively. Hasbro was early in outsourcing a lot of toy production/getting it off balance sheet (before Mattel), which reduced capital intensity-- cap-ex totaled ~1.5-2.5% of total sales.

            On 2023 estimates, Hasbro trades at 9.4x E2023 EV/EBITDA and ~12x E 2023 P/E. These multiples represent a discount to the 5-year average forward EV/EBITDA multiple of ~12x and P/E multiple of 19x. While I do not expect Hasbro to have a strong top-line growth story, I do believe that the strategic initiatives (licensing/selling part of eOne/focus on growth of the larger brands) should improve profitability over the next several years; earnings should grow and the multiple should expand to reflect the positive structural changes in the business. Likewise, the industry headwinds could turn into tailwinds. In 2025, if Hasbro can generate $6B in sales at a 20% EBIT margin, the Company could earn ~$6/share. At 15-20x P/E, the stock would be worth 90-$120/share versus $52 today. An investor does not need a large multiple re-rating, or a premium multiple, to generate a good return from the current price. The quality of the IP, durability of the business combined with the less leveraged balance sheet and more focused busines model should support a higher multiple. With Hasbro, you should get earnings growth and multiple expansion. In exchange, you must buy into a depressed toy and consumer discretionary market, must underwrite uncertainty around the timing and value of the eOne deal, and must have some confidence in a board/management team that has damaged trust with investors.

It is worth pointing out the strength of IP and economics of Hasbro’s gaming business, which I think makes Hasbro unique among toy companies. Hasbro’s Wizards of the Coast gaming business is a gem, with its two main properties (Magic the Gathering/Dungeons and Dragons) establishing a durable, recurring revenue stream supported by a large built-in-base of loyal players and fans. Hasbro’s gaming business appears less affected by the vagaries of the toy market and generates segment level operating margins that are much higher than peers. In 2020, 2021, and 2022, Hasbro’s Wizards of the Coast and Digital gaming business generated $906m, $1.2B, and $1.3B in revenue (split between tabletop and digital), with segment operating profit of $420m, $547m, and $538m, respectively. As reported, the gaming business generates ~40% segment operating margins, closer to software margins than toys. You can make a case (which Alta Fox tried to do), that the gaming business standalone could be worth close to, or more than entire market capitalization of Hasbro. A sale of Wizards of the Coast would attract immense interest.

I am not aware of many companies with the breadth and quality of owned branded IP of Hasbro. Among the properties (Peppa Pig/Transformers/Power Rangers/GI Joe/Play-Doh/My Little Pony/Nerf/a very large library of well-known board games (Candy Land/Hungry Hungry Hippo)—Hasbro has a presence in key categories such as action figures, preschool, board games, and crafts. There is also a strong nostalgia factor as many parents grew up with these brands and toys and therefore have a strong emotional connection with them that they can relive or access through their kids. The fact that so many generations know the rules to the games also is an underappreciated advantage—it broadens the market, supports intergenerational game-play, and widens the community, which is part of the appeal for games.

            Branded family and branded gaming IP is valuable to financial and strategic buyers. Moonbug, the owner of Cocomelon, sold for a reported $3B in 2021 to a PE backed entertainment company run by former Disney executives (Candle Media). The Swedish gaming company, Embracer, acquired Middle Earth Enterprises, the holding company that controls a broad set of IP rights to Lord of the Rings, last year for what was reported to be $770m. Other content assets (Dreamworks/MGM) sold for very large EBITDA multiples given their scarcity and strategic value. Pieces of, or the entirety, of Hasbro’s very deep catalog of IP would likely have immense value to a strategic buyer.

There are several inherent negatives to the core toy business: 1-hit-driven; 2-customer taste and preference are fickle and hard to predict; 3-digital platforms continue to grow in terms of consumer attention and dollars; 4-highly seasonal with a large percentage of the business occurring during the holiday;-5-inventory risk; 6-slow top-line growth that must contend with upstarts and competition.

Despite the negatives, Hasbro (and Mattel) have been very durable, in part due to their iconic owned IP, valuable distribution, relationship with retailers, diversification across lines of business, and capacity to innovate. I would expect both to remain durable and resilient; the low multiple creates an attractive entry in the stock.

Catalyst

sale of eOne

toy industry rebounds