Description

Summary

Hong Kong-listed Playmates Toys Limited is a micro-cap (US$60mn market capitalization) toys-maker trading at a significant discount to net cash with significant upside optionality. The stock has the characteristics of a traditional bargain issue: (1) selling below liquid asset value, (2) no apparent danger of dissipating these assets, and (3) a history of large earnings power. Mispricing is likely driven by low near-term earnings visibility, small capitalization, and Hong Kong listing (despite >90% of revenues generated in the US & Europe).

Investment Thesis

The investment thesis rests on the following:

1. Low probability of permanent capital loss – Recent stock prices value the company below net cash on the balance sheet, suggest substantial downside protection for investors. Playmates Toys can be characterized as a situation with high uncertainty (particularly on timing to recovery) but low risk of meaningful capital loss.

2. Prospect of future upside optionality – Playmates Toys has experienced periods of substantial earnings power coinciding with Teenage Mutant Ninja Turtles television series relaunches. A recovery in revenues and earnings would likely drive substantial rerating; the market would likely reprice both the company’s earnings power and assign higher value to balance sheet cash given increased probability of cash distributions.

3. History of minority shareholder and shareholder alignment – Playmates Toys is 50.85% owned by listed Playmates Holdings, which in turn is 64% owned by the founding Chan family. See golfer23’s write-up of Playmates Holdings from 2015 for more detail. Playmates Toys has an incentive to pay dividends to shareholders (assuming future successful TMNT relaunch) and has done so previously.  

Company overview

Playmates Toys Limited (Playmates) designs, develops, and distributes toys. The company was founded in 1966 with a focus on dolls and preschool toys and has been listed in Hong Kong since 1984. Playmates first big success occurred in 1988, when the company developed and marketed the Teenage Mutant Ninja Turtles (TMNT) action figures. TMNT was one of the most popular morning kids shows in the US during the 1990s and TMNT action figures became one of the best-selling toys in history. Playmates has manufactured all TMNT action figures since the original series debuted and retains the exclusive license; the company has diversified into other franchises (Ben10, Voltron, Godzilla vs. Kong) but past and future operating performance is closely linked to TMNT’s numerous reinventions.

There have been four major TMNT series and associated action figure sets:

·         1987-1996: The original television series.

·         2003-2010 – Teenage Mutant Ninja Turtles: Aired on TMNT 4Kids TV with critical and commercial success

·         2012-2017 – Teenage Mutant Ninja Turtles: 3D reimagining aired on Nickelodeon. Debut ratings were the highest for a Nickelodeon animated series since 2009. This period also coincided with the Michael Bay live action theatrical releases (2014 and 2016).

·         2018-2019 – Rise of the Teenage Mutant Ninja Turtles: Also aired Nickelodeon. The series failed to achieve the success enjoyed by previous reimaginations and was cancelled in 2020. Rise of the Teenage Mutant Ninja Turtles action figures are being phased out by Playmates.

Most revenues over the last five years have been generated in the US (>50%) followed by Europe (20-30%) with the remainder from the rest of Americans and Asia Pacific.

Financial analysis

Recent financial results appear concerning at first glance; revenue for the FY2020 fell 19% y-o-y to HK$289mn and the company reported operating losses of HK$23mn (2.55 loss per share). COVID-19 had a negative impact, preventing Playmates from launching new branding to offset contractions in TMNT sales.

However, 2020 results need to be considered in the context of other similar historical periods. Playmates Toy’s financial results have fluctuated alongside timing and success of each TMNT series. Each pre/post TMNT action figure launch follows a similar two-stage playbook:

Stage 1 – Initial pre-release and development period: Cash is stockpiled. Production of TMNT action figures associated with the previous series are actively halted and inventory winds down. Sales fall sharply and operating income goes slightly negative. For example, in preparation for the TMNT relaunch in H1 2010 turnover fell to HK$75mn from HK$300mn in H2 2009 (peak revenue of over HKD$1.2bn in 2004 and 2004 following the 2003 launch). Annual revenue fell to a low of HK$45mn in 2011.

Stage 2 – Re-launch alongside new series: Newly developed TMNT action figures are launched alongside the new TV series. If the series is well received, sales spike for the following two to three years. For example, production restarted in 2012 alongside the new Nickelodeon series. Playmates revenue rose to HK$371 in 2012, HK$1,658 in 2013, and peaked at HK$2,160mn in 2014, gradually declining until the series ended in 2017. The company generated HK$1.7mn of cash flow between 2012-2017 and paid almost HK$640mn in dividends.

Playmates' FY2020 operating results are similar to other previous Stage 1 periods. Production of TMNT action figures is on a planned hiatus as the company collaborates with ViacomCBS-Nickelodeon to develop a new version of the TMNT television series. As with similar past periods, the company capital structure is conservative with minimal liabilities (total liabilities HK$139mn as of 31 Dec. 2020), >7x current ratio and no financial debt. Playmates burned HK$49.6mn (US$6.3mn) in FY2020. Interest received on cash invested more than offsets payment of lease liabilities.

Cash burn is manageable due to the highly variable cost structure. Playmates held HK$950mn (US$ 123mn) in cash and HK$7mn in marketable securities as of 31 Dec 2020, versus HK$1,005mn (US$129mn) on 1st Jan 2020. The company enters into contractual licence agreements and pays royalties to owners of established brands. Manufacturing is subcontracted with the principal suppliers of finished goods based in Southern China (roughly 10 vendors chosen for quality and safety). This provides a highly flexible cost structure requiring minimal cash outlay during periods of low demand. Sales and marketing expenses ramp up alongside TMNT product launches but are otherwise steady as a percentage of revenue (~25-30%). General & administrative (fixed) costs have been stable at HK$120-125mn per annum over the past three years. Capex is minimal (<1% of revenues); ViacomCBS-Nickelodeon owns the TMNT franchise and shoulder ongoing brand investment. Of course, this arrangement has positives (low ongoing capex by Playmates) and negatives (lack of control and risk of Viacom underinvesting).

Valuation

Liquid asset value – Playmates Toys is significantly undervalued on most traditional measures other than near-term earnings power. Enterprise value at latest market trading levels is currently negative HK$479mn; HK$466mn market capitalization plus HK$12mn total debt less the full cash & marketable security balance of HK$957mn. Cash less total liabilities is HK$0.69 per share (1.75x current share price). Current asset value less total liabilities suggests HK$0.79 intrinsic value per share (2.0x current share price). Discounting the latest cash figure by 50% would approximate the current market price per share; it would take 10 years to reach that figure at the FY2020 cash burn rate.

Note there is little reason to suspect near-term cash distributions absent renewed profitability despite common stock trading levels below conservative liquidation value; management’s decision to retain high cash balances is strategic, and arguably prudent from a longer-term perspective, given uncertainty over timing and success of future TMNT launches.

Earnings power value – Playmates Toys has proven long-term earning power, albeit with multi-year periods of suppressed revenues. Uncertainty regarding the timing of sales recovery makes earnings power difficult to quantify. Given the discount to liquid asset value, the share price clearly assigns near-zero probability to recovery of future earnings for the foreseeable future unless a more meaningful cash burn or other asset dissipation is expected. No firm details on the TMNT relaunch have been shared, although there were reports in 2020 that Nickelodeon is rebooting TMNT for the big screen with Seth Rogen’s Point Grey Pictures.

We can simplistically apply revenue multiples from previous Stage 2 periods to approximate potential optionality. Even if revenues recover to well below the 2013/2014 peak (i.e. HK$1bn or half the 2014 peak), similar market valuations would imply share prices 3x (1x EV/Sales) to 5x higher (2x EV/Sales) current trading levels.

Cash generation potential from a successful relaunch would be meaningful relative to the current market capitalization. Playmates generated HK$1.5bn of free cash flow during the 2012-2018 relaunch. A successful relaunch should generate FCF equal to at least 30-40% of current market capitalization over 3-4 years, assuming much lower peak revenues than 2014 (HK$1.0-1.3bn) and similar margins to other successful relaunches (2003-2009, 2012-2018).

Risks

Opportunity cost and timing – Shareholders are unlikely to receive cash distributions absent a return to profitability. If reimagined TMNT is unsuccessful (i.e. similar to Rise of the Teenage Mutant Ninja Turtles) or delays occur beyond 4/5 years than that would damage the investment case and lower annualized returns.

Accelerated cash burn – Deterioration in net current asset value would occur faster than expected and reduce shareholder value

Governance – Elevated risk given the jurisdiction and small capitalization (no material red flags discovered)

US-China trade disputes – Renewed trade disputes could challenge the supply chain

Catalyst

• Reported progress on TMNT relaunch
• Cash distributions following return to profitability