Description

Mattel is an iconic toymaker well into a turnaround that few investors are paying attention to. From 2013-18, a CEO carousel, operational missteps and resulting balance sheet peril led many to sell their holdings and never look back. 

In a few years, MAT went from being perceived as a branded consumer goods company approaching P&G or Nike’s quality to an overleveraged structural short, poised to suffer from the impact of technology on kids’ play habits.

Since current CEO Ynon Kreiz joined in 2018, the strategy has been simplified (“IP driven, high performing toy company”), $1B of structural costs taken out of a $5B revenue company, and revenue and profits are growing again.

Despite an overhaul of the business, at 13.5x EBIT, shares trade below long-term 15x multiple while improvement seems to be accelerating. Credible sources of optionality (IP-driven film and TV projects, new toy licenses) are also likely to appear in financial results in 2023 and beyond. 

Business model

Mattel sells toys under the following categories: Dolls, Vehicles, Infant/Toddler/Preschool, and Other. Within these segments, Power Brands include Barbie, Fisher Price, Thomas & Friends and Hot Wheels. Mix by gross billings is shown below. 

Revenue is ~55% North America, 40% Int’l, 5% American Girl, but profits are ~70/30 NA/Int’l.

Value proposition

Very straightforward. Mattel creates products that bring joy to children. After facing headwinds over the years for a non-inclusive Barbie image, the company introduced many more SKUs that should resonate with any family. In general, families like to make kids happy, and Mattel offers a very affordable way to do so throughout its entire portfolio.

The value proposition to creatives working with the growing media business is a heritage-rich IP library that can be mined for better risk-adjusted content than available by starting from scratch. An example is the dormant Major Matt Mason franchise, which I had never heard of until researching Mattel. This is an action figure astronaut that lived on the moon and was originally introduced in 1966. It is being reintroduced as a film with Tom Hanks. Similar to Marvel’s success in reviving dormant superheroes into flagship properties, Mattel believes there is opportunity to pursue this strategy with concepts like Mason.

“We went to the marketplace with a list of 10 pages of IP that we thought might be interesting. People were interested, but when we hired Robbie Brenner to run our film division, she had conversations with writers and directors–within a week we were in advanced conversations with a multiple Oscar-winning writer and Tom Hanks. The two of them are interested in one IP that was not even on our 10 page list, just to tell you how deep and broad and diverse the library is. We didn’t think there’s a movie there, but clearly two of the greatest creators in the industry believe in the opportunity. And bringing the analogy back to Marvel, when Disney bought Marvel, no one looked at Black Panther or Guardians of the Galaxy and said “here’s our next billion dollar franchise” but a creative team at Marvel knew what to do with it and it became what it is.”  

- KindredCast, hosted by Aryeh Bourkoff; 12/14/18; “Mattel Chairman & CEO Ynon Kreiz” https://www.kindredmedia.com/sitecore/content/KindredApp3/KindredCasts/KindredCast-44

A similar strategy was successfully pursued at Disney.

Q: “I wanted to ask about the film studio. How do you reassure investors who worry that Marvel’s best known IP is locked into long-term licensing deals and its lesser known IP will be difficult to monetize?”

A: “Well, Iron Man was probably in the lesser known IP category not that long ago, and Marvel came out with a great movie and now it’s a better known IP at Marvel.”

- Bob Iger, Disney CEO; Goldman Sachs Communacopia Conference; 9/21/10 

Source of mispricing

Mattel’s recent history provides context for why this opportunity exists. After decades as a mostly predictable, high margin, affordable consumer goods company, Mattel embarked on a series of execution and leadership missteps that called its survival into question. 

From roughly 2012 until 2018, Mattel became viewed as a dying business (with the results to match!) and burned so many investors that it was discarded–sentiment has yet to fully recover. 

Fortunately, the clearly articulated turnaround strategy from 2018 is ahead of plan, with tangible results. Shares have not fully caught up to reality, providing investors an opportunity. Below is financial depiction of the decline and current revival:

Peers

Mattel trades at reasonable valuation relative to direct peer HAS, and recently won the Disney Princess/ Frozen license (lost to HAS in 2016, MAT begins selling in 2023). The company has withstood inflation and supply chain issues thus far, a testament to its brands and recent years’ investment in operational resilience. If strong performance continues, investors may again compare MAT to branded consumer stalwarts such as PG and DIS. While they are aspirational comps, I included them to illustrate potential 2x multiple expansion in a blue sky bull case. 

Risks

Inflation/Supply chain. Hard to know how these will impact long-term performance, but MAT seems better positioned than most companies. Its brands are important to retailers and consumers, so tends to have better negotiating leverage than most businesses. FY21 gross margins were impacted -400bps, and overall declined 80bps. Inflation has been manageable with pricing and cost savings thus far. 

Barbie perception. Despite years of investing in expanding the definition of “Barbie,” Mattel is sometimes criticized for the doll’s body image and the message it sends to girls. Perception is evolving toward reality of a much more inclusive toy, and recent growth has been impressive, but this is a headline risk for a product comprising 28% of FY21 gross bookings.

Retail concentration. At 12/31/21, 46% of revenue went through Walmart (21%), Target (14%) and Amazon (11%). This concentration is slightly lower than prior years, but remains a key risk. Mattel benefits from owning brands that drive store traffic, so there is mutual dependence. As content becomes a bigger part of the revenue base, this risk should also be reduced.

Executive pay. Management compensation is very generous, and despite strong performance, it could create tension if the fruits of turnaround are not shared widely. For whatever reason, this seems to be a feature of the media industry, and there are no signs that this is impacting Mattel’s performance, but violates a Fisher 15 rule that is worth noting.

Valuation

The below chart summarizing DCF (assumed 8% WACC) shows implied expectations assuming mid-single digit revenue growth and various EBIT margins. Current price implies declining margins despite improving revenue mix and new product introductions.

Modest margin improvement as revenue grows seems attainable considering the evolution to higher margin IP-driven revenue and sustainable manufacturing costs taken out of the P&L.

The below chart estimates valuation at various EV/EBIT multiples assuming modest multiple expansion. The risk/reward given current momentum seems decent.

Catalyst

• IP monetization becomes visible. Mattel is developing 14 films as of early 2022, with Barbie movie (Margot Robbie) currently in production. Investor enthusiasm may grow as these projects come to market. A handful of projects underway include Major Matt Mason (Tom Hanks), Polly Pocket (Lena Dunham), Barney the Dinosaur (Daniel Kaluuya), Rock Em Sock Em Robots (Vin Diesel), He-Man (Kyle Allen) among others. In addition to high margin income from these projects, there is also potential to further grow the core business as toys are developed to pair with the releases.

• Resume capital returns (suspended dividend in 2017). Mattel had paid a steady dividend until the balance sheet became a problem. It has not had the best timing on buybacks. With FCF returning and leverage approaching target 2-2.5x, management will consider options. Kreiz noted 3/10/22 “Once we achieve [<2.5x Debt/Adj. EBITDA] and maintain it, we’ll have the flexibility to consider other priorities including M&A and share repurchases…At this point we’re not thinking of dividends, but further down the road we’ll have optionality to take action that will optimize shareholder return.” 

• Concept revivals. After losing the license to Hasbro in 2016, Mattel has regained Disney Princess/ Frozen. The account was rumored to have $500m revenue in 2014, so could be material to future growth. It will be led by the Barbie team at Mattel. Another lapsed property coming back FY22 is Monster High, which will have a show on Nickelodeon and associated merchandise. This was a $1B brand a decade ago.

• American Girl resurgence. American Girl was once the gem of Mattel, selling high priced dolls to girls with a luxury retail experience. Due to private label competition, sales declined from >$600m in 2014 to a trough $258m FY20. Margins went from +20% to -20%. As of FY21 sales are growing again and the business is break-even. If recovery continues, even a portion of prior performance could become a decent contributor to EBIT. 

• Collectors items, NFTs, etc. I do not ascribe value to this, but Mattel has launched NFTs and high end collector’s items of certain Hot Wheels and Barbie products. It is another revenue stream, could have DTC benefits and also provides decent PR.