Description

Summary

Playboy is in the midst of a structural and financial turnaround that will become evident over the next several quarters, providing shareholders with a possible 100% return.  This iconic American brand has huge earnings potential and is finally being positioned to realize it.  The genesis of this turnaround is a focus on high margin licensing while reducing the cost structure greatly across its print/digital and entertainment segments.  I believe the stock will be worth $8-9 in a year.  On a separate note, the 3% converts are yielding 8% to 3/15/12 put, not a bad place to park cash next 2 years given very strong asset coverage. 

Company

The company breaks out its business into 3 segments:

• 1) Entertainment: Production and marketing of content to cable & satellite providers globally. Playboy and Spice channels are carried by a variety of TV providers as well as Video-On-Demand offerings. International TV is experiencing heavy competition, especially in the UK, and domestic VOD is very competitive as well. Both businesses have a headwind given extreme competition in erotic material, as well as the internet being a main source of free content. Management has responded but cutting costs dramatically, both in programming and SG&A. This helped EBIT actually go up last quarter in this segment, even while revenues fell.
• 2) Print/Digital Group: Magazine and website businesses - both subscription and advertising. Website continues to see revenue drop due to heavy free content competition. Management has lowered the guaranteed circulation of its monthly magazine from 2.6mm to 1.5mm to appease advertisers and lower costs. Heavy competition and the economic impact on advertising have hurt the print segment. The reduction in rate base for Playboy magazine as well as heavy reductions in manufacturing and shipping costs is helping offset revenue loss and this segment also saw nice improvement in EBIT year over year. The price of the magazine may also go up slightly in an attempt to boost margins. The biggest move was outsourcing all non-editorial functions of Playboy to American Media late last year. This should improve EBIT by over $10mm annually once fully recognized, most likely over next quarter or two.
• 3) Licensing: the crown jewel and focus of the company going forward. Seeing growth mainly in Asia and management expects this to accelerate given new IMG agreement to handle all licensing in Asia going forward. Management has been very vocal about the licensing opportunity in Asia and in fact, stated the entire licensing business could double due to Asia by 2013. That would add $20mm+ in EBITDA. This business did $6.5mm in EBITDA last quarter alone.

In addition, the company owns the mansion on 5 acres, valued conservatively by a local LA agent at $50mm.  As a point of reference, a nearby property on 3.2 acres sold for $53mm last year and obviously doesn't have the cache and prestige of being the Playboy mansion.  He thinks $100mm is possible in the future.  The art collection in the mansion is estimated at $10mm by a publication a few years ago so a very rough estimate. 

History

The history of value destruction at Playboy is well documented, but I believe we are finally seeing a turnaround that is built on a solid, well thought out plan by a focused CEO.  Hef has no doubt for decades utilized corporate resources for his own enjoyment and image, both of which took precedent over shareholder value.  That is changing with the board of Hef cronies recently making a good decision hiring Scott Flanders; 2010 and especially 2011 should highlight this with much stronger financial results.  He was previously at Freedom Communications for 3 years as CEO and at Columbia Records for 6 years as CEO.  He returned both to profitability before selling both companies for a multiple of the value upon his employment.  Expect the same result here. 

Valuation

Market cap at $4.34/share with 33.54mm shares out is $146mm; Hef still controls through A shares voting power

Debt - $115mm face; $30mm untapped credit facility

Cash - $25mm

Enterprise value = $236mm

Doesn't appear cheap on cash flow or earnings metrics yet, but value of assets is far more than the enterprise value.  Here is a breakdown of the assets:

Mansion - $55mm

Art - $10mm (article from 2 years ago estimating value - albeit not documented so very rough estimate)

Cash - $25mm

Licensing business - $208mm (8x runrate EBIT of $26mm - 70% margins); nearly covers Enterprise value alone and doesn't include Asia growth expected over next few years.

Below are financials for 2007-2009, followed by my estimates for 2010 & 2011.  Getting to 2007 levels of EBITDA or greater are achievable.  With recent magazine outsourcing to American Media, that should be $10mm positive impact on EBITDA in print/digital segment.  Already starting to see the positive impact last few months as segment is breakeven.  Total headcount is down a third but corporate expense is still too high.  Closing the NYC office was a smart, albeit expensive at $9mm, move and 2010/11 corporate expense should be well below $25mm.  Assuming licensing doubles (easily attainable according to Flanders) by 2013, that is $26mm of additional EBITDA, coupled with $10mm benefit above and $5mm more of cost cuts gets to $40mm+ of EBITDA improvement over 2009 level of $7mm.  7x my 2010 post corporate expense EBITDA estimate of $50mm yields a $350mm enterprise value.  $90mm in net debt, minus 50% of art/house value or $33mm, yields $293mm of equity value, or $8.74/share - 100% upside.    

* Assumes utilization of entire $8mm remaining NOL over next 2 years, which may be unrealistic.  Waiting for color on this from management.

**Assumes 30% tax rate given int'l operations

Catalyst