The Topps Company, Inc. TOPP
April 04, 2006 - 9:23am EST by
2006 2007
Price: 8.85 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 350 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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The Topps Company, Inc., the owner of iconic children’s brands such as Topps baseball cards and Bazooka bubble gum, is selling at a discount to the recently validated value (through an aborted auction process) of only one of its businesses, comprising approximately 50% of sales. It carries no debt and substantial cash, adding significantly to the margin of safety. It has further committed to returning cash to shareholders at a rate of 25% per annum.

Topps has a $350 million market capitalization (40.0 million shares at $8.35) and a $262 million total enterprise value. Confection, representing approximately one-half of the company’s $300 million in sales, is alone worth approximately $275 million, or more than Topps’ total enterprise value. Entertainment, a hit-driven business that has not had a hit since Pokemon in 2000, could be worth another $100-150 million. The company also has $92 million in cash, for a potential value of almost $500 million. On a per share basis, confection, entertainment and cash would be worth approximately $6.85, $3.10 and $2.30, respectively, or $12.25 in total. Put differently, if confection could be sold for $6.85 per share, investors purchasing stock today would have no downside and would be paid to own entertainment.

Important coming dates include:
 April 10th conference call to discuss the fiscal 2006 fourth quarter and year ended February 28, 2006
 June 30th is the annual meeting

Business Economics
2/2001 2/2002 2/2003 2/2004 2/2005 LTM
Sales $170.7 $152.1 $146.9 $147.2 $143.8 $144.3
Contribution 64.4 54.9 52.1 45.7 46.8 42.5
% 37.7% 36.1% 35.5% 31.1% 32.5% 29.5%
Sales $266.7 $148.1 $143.2 $150.2 $152.1 $151.7
Contribution 119.7 47.5 39.3 42.5 45.1 37.9
% 44.9% 32.1% 27.5% 28.3% 29.7% 25.0%

The confection business includes several lollipop products, including Ring Pop (introduced 1977), Push Pop (1986), Baby Bottle Pop (1998) and Juicy Drop Pop (2003), as well as Bazooka bubble gum (1947). Ring Pop, which is manufactured at Topps’ Scranton, PA facility (80 employees) is the only product Topps manufactures, and only for its domestic sales. It is possible that savings could be realized by moving Ring Pop production overseas as well, where savings on sugar costs could be significant (potentially offset by freight costs for the ½-ounce product). The other larger lollipop products are manufactured by a single supplier in factories located in Taiwan, Thailand and China. CFO Catherine Jessup believes Topps’ relationship with its supplier may have grown “too comfortable” and that better terms may be achievable.

Bazooka had been manufactured at the company’s Duryea, PA facility until it was closed in December 1996. Topps subsequently entered into a contract manufacturing agreement with The Hershey Company, Inc. During the third quarter conference call in January 2006, President & COO Scott Silverstein (who is Shorin’s son-in-law and a former attorney) made the extraordinary disclosure that Sam’s Club shoppers could buy competitors’ chunk bubble gum “for less money than we were purchasing the product for from [Hershey].” Topps finally responded by moving Bazooka manufacturing to Mexico, a process currently underway, and Jessup believes Mexican-manufactured gum will be cost-competitive.

Confection began placing its confection products in retail stores through Crossmark, Inc., a national food broker with 13,000 sales associates, in January 2005. Before that, Topps relied on a regional broker network. Topps’ experience with Crossmark has lagged its expectations, possibly because Topps is an insignificant customer and has difficulty gaining an appropriate level of attention.

Baseball cards are produced under license agreements with the Major League Baseball Players Association (MLBPA) and Major League Baseball Properties (for trademark and copyright use). These license fees total approximately 19% of baseball-related sales. Photographs are taken by freelance photographers and Topps’ own graphic artists and editors manipulate the images and supply artwork, text and statistics. Printing has long been done by outside printers, and in 1996 Topps began outsourcing the cutting, collating and wrapping of cards to contract packers. Entertainment card images are typically supplied by the licensor.

Cards are sold to national accounts, such as Wal-Mart, by Topps employees. Topps’ largest customer, McLean, is a distributor that re-sells to smaller accounts. Larger retailers generally have the ability to return unsold product, which Topps destroys. Hobby shops do not share that ability, but are serviced by Topps’ own staff.

Cost-cutting opportunities. The entertainment and confection businesses are run separately and have almost no synergies; gum has not been included in card packs for years. Nevertheless, the majority of general and administrative expenses, totaling approximately $76 million, are not allocated between the two businesses. This practice, which management plans to change imminently, created incentives for managers of both businesses to add overhead, since it is not included in performance calculations. This tendency was reinforced by a culture routinely described, even by the CFO, as “paternalistic.” As a result, the company continues to employ approximately 485 people, only 80 of whom are engaged in manufacturing operations. Despite a headcount reduction in 2005, headcount remains above what it was in February 2000 after adjusting for the WizKids acquisition. In the reasonably near future, managers will be paid based on confection and entertainment operating income on a fully-allocated basis.

Both allocated and unallocated general and administrative expenses together comprise 34% of sales. Tootsie Roll Industries, Inc., a family-controlled company and the most comparable publicly-traded one with sales of $488 million, reports approximately 20% SG&A/Sales and a 19% operating margin. A 1% decrease would add approximately $3 million in operating profit or almost $0.05 EPS for Topps.

In 1998, The Upper Deck Company, Inc. (Topps’ only sports card competitor as of the 2006 season) began purchasing professional, game-used uniforms and equipment, shredding them, and including pieces of the shredded material in so-called “relic” cards inserted in packs; it also contracted with players for autographed material, also randomly inserted in card packs. Topps initially resisted the practice, with Shorin comparing it privately to a drug that would provide only a short-term boost to sales because it did not enhance the underlying product. Fearing lost market share, however, Topps reluctantly followed Upper Deck. Industry sources estimate that Upper Deck and Topps each spend approximately $2-5 million annually without evidence the expenditures continue to increase sales.

Confection Sale Process. On April 29, 2005, Pembridge Value Opportunity Fund, LP notified Topps of its intention to nominate three directors for election at the June 30th annual meeting. Pembridge, a fund led by a former Skadden Arps mergers & acquisitions associate and investment banker, wanted Topps to “explore all strategic alternatives to maximize shareholder value, including the sale of all or part of the Company, a large special dividend or a significant share repurchase either in the open market or as part of a self tender offer.” Topps responded the following day that it was already doing precisely that and had, in fact, retained Lehman Brothers “in early 2005” to evaluate the sale of the confectionery business. Perhaps because Pembridge’s goals appeared to have been achieved even before they had been announced, Pembridge and Topps agreed on June 9th that Pembridge would terminate its proxy solicitation, withdraw its director nominees and stand still until December 31, 2005. Topps, for its part, would refrain from adopting a poison pill until June 30, 2006 (it had not had one in years) and agreed to pay Pembridge $50,000 for expenses.

Jessup stated that first round information regarding the confection business was sent to 8 parties. First rounds are typically much larger because success in any auction-format divestiture is dependent on creating competition amongst potential bidders. A second round was completed, with the entire process taking nearly seven months. At least one second round bid was brought to the board for consideration. On September 12th, Topps announced that “levels of interest by prospective purchasers… were not commensurate with the Board’s valuation of the asset” and that the sale process was terminated.

As Shorin explained two weeks later during the second quarter conference call, the decision to pursue a divestiture had been influenced by the confection industry’s rich acquisition multiples. In 2005, Wrigley purchased confectionery assets of Kraft (Joyco), including brands such as Altoids and Life Savers, for approximately 2.4 times 2004 sales net of cash tax benefits. Tootsie Roll acquired Concord Confections, maker of Dubble Bubble, in 2004 for 2.8 times 2003 sales. In 2001, Perfetti purchased Van Melle N.V., maker of Mentos and Fruitella, for approximately 2.3 times sales. Shorin said that “if there was an interest along those lines, the Board would have given them serious consideration.” Had an offer been received “along those lines,” at an average of 2.5 times sales, it would have meant $360 million, representing approximately $9 per share before $2.30 in cash and the entertainment business. Investors were left wondering whether other offers might have merited serious consideration. Tax considerations, it should be noted, did not play a significant role in the decision, since Jessup confirmed that a divestiture might have been completed “tax-efficiently.”

Industry Structure. Topps was founded in 1938 by four Shorin brothers. Its first success came during World War II, when Wrigley’s created an opportunity for domestic suppliers of adult chewing gum by dedicating all of its production to U.S. troops. In 1947, Topps responded to Wrigley’s re-entrance by introducing Bazooka Joe bubble gum (named for the wind instrument rather than the weapon), which it marketed to children by wrapping each piece in a comic strip. The following year, it introduced gum cards (Hocus Pocus Magic Photos) as a vehicle for promoting chewing gum, packaging several cards together with a stick of gum, a marketing strategy that had been pioneered in the 1930s by the Goudey, DeLong, National Chicle and Gum Inc. (later Bowman Gum) companies. Hopalong Cassidy cards followed in 1950.

Bowman Gum, Inc., which had been producing baseball cards since 1948, had one-year exclusive contracts with major league players to produce gum cards. Topps entered the baseball card business in 1951 with two playing card-like, 52-card sets that it packaged with caramel; it included in its player contracts the right to sell gum cards beginning in 1952, which it did. Topps acquired Bowman in 1956 and retired the brand (reintroducing it in 1992, positioned as a “rookie card” brand).

Topps negotiated multi-year contractual exclusivity with major league players. The Fleer Corporation (now part of Upper Deck) attempted to compete by introducing a baseball card set featuring only Ted Williams in 1959 and other smaller sets until it turned to the FTC, alleging unfair competition. The FTC ruled that Topps’ contracts were not anti-competitive since Fleer could sell baseball cards together with any product other than gum, which Fleer chose not to do.

Fleer revived the issue in 1975 when it sued Topps in District Court alleging that its exclusive contract with the MLBPA constituted an “illegal restraint of trade.” The Court ruled in July 1980 that Topps had “unlawfully restrained and monopolized trade” and urged the MLBPA to carefully consider all card licensing applications. Incidentally, Arthur Shorin, the son of one of the founders, was named CEO in February 1980. The Third Circuit reversed that ruling in 1981, arguing that rivals could compete ''by seeking licenses with minor league players.'' Both Fleer (then owner of Dubble Bubble gum) and Donruss (with its Super Bubble gum), however, had already signed license agreements with the MLBPA before the judgment was reversed. Upper Deck entered the market in 1989.
In addition to baseball cards, Topps had produced non-sports cards every year, including licensed sets related to entertainment, television, movies as well as non-licensed products. Wacky Packages, which were stickers featuring parodies of consumer products produced by Topps’ own staff, was enormously successful, with sales exceeding $100 million and significantly higher margins because it was not licensed. As the following link demonstrates, the non-sport product life cycle was typically one year or less. Wacky Packages were produced from 1973-1975.

Topps went public in 1972 and prospered with Wacky Packages’ success. The founding Shorin brothers retired, and Arthur Shorin was named CEO in 1980. Arthur and other family members, then together owning approximately 38.5% of Topps, led a leveraged buyout in 1984 sponsored by Forstmann Little at a $104.3 million valuation relative to approximately $70 million of sales.

Hit Products. Interestingly, in fiscal 1985 and 1986 Topps did not achieve the sales and profitability targets Forstmann Little had shared with financing sources. Entertainment cards are a hit-driven business, however, and in 1987 a hit finally came. Garbage Pail Kids, cartoon stickers sold in packs, increased in sales from approximately $9 million to $48 million. Not surprisingly, Topps filed its IPO prospectus with the ink on the year-end audit barely dry. I remember a Forstmann Little partner stating some time after the offering that it had been the firm’s investment thesis to purchase Topps when it had no hit and sell it when it did.

Topps’ next hit was Pokemon, its most successful license ever. Pokemon sales were $87.4 million, $140.6 million and $18.2 million in fiscal 2000, 2001 and 2002, respectively. Topps did not have to hire a single person to produce Pokemon, according to Jessup. Perhaps not coincidentally, Topps’ highest share price during the last ten years was achieved on December 28, 2001.

Positive Changes in Industry Structure. The MLBPA agreed, beginning with the 2006 releases, to limit its baseball card licenses to Topps and Upper Deck; Fleer’s assets were acquired by Upper Deck and Donruss exited the business). This license structure aims to correct the deleterious effects that began in the late 1980s and early 1990s when the four licensees began experimenting with product proliferation to segment their customers. Although Topps had manufactured cards for decades with only one or two different baseball products each year, by 2005 it had two dozen. Consumers lost interest, hurting sales, and shorter product runs resulted in lower margins. In return for the MLBPA limiting the number of licensees, Topps and Upper Deck agreed to spend more on advertising.
Strategic Choices. Topps enjoyed a near-monopoly from 1956 until 1981 and its brand, with its rich history, remains virtually synonymous with sports cards. It was Upper Deck, rather than Topps, however, that extended its brand to licensed memorabilia with the 1992 launch of Upper Deck Authenticated (UDA). UDA sells autographed balls, jerseys and other items with a patented authentication system that guarantees that an Upper Deck employee witnessed the signing. Steiner Sports, a private company, sells approximately $50 million per annum of similar merchandise through exclusive contracts with players such as Derek Jeter.

Topps also considered, but rejected, extending its brand to card grading. In 1991, Professional Sports Authenticators (PSA), a unit of Collectors Universe, Inc. (CLCT) began authenticating and grading cards (the majority of which may have been produced by Topps) on a 1-10 scale. PSA then encapsulated the card in a tamper-proof holder with its description and grade. It now charges $6-20 per card, depending on the declared value. Since 1991 PSA has graded more than 6 million cards and its current run rate is approximately 1 million cards per annum. Capital expenditures are negligible, and industry sources estimate that graders process as many as 1,000 cards a day (PSA has 3 grade each card).

Top 5 Shareholders
Private Capital Management, Inc. 9,507,000 23.7%
Merrill Lynch & Co., Inc. 3,226,000 8.1%
Royce & Associates, LLC 3,000,000 7.5%
GAMCO Investors 2,632,000 6.6%
Arthur Shorin 2,318,000 5.8%

Private Capital sold 682,000 shares during the quarter ended December 31, 2005. GAMCO is the only 13D filer (June 2005) and added to its position in January. GAMCO’s basis is approximately $10.08 per share. On July 14, 2005, weeks after the Topps-Pembridge settlement but months before the confection sale process was terminated, Barron’s quoted Gabelli in its roundtable discussion:

Topps is a similar story. The stock is $9. The company's confectionery business grosses about $140 million, and its contribution margin is about $45 million. Total EBITDA is $19 million. The collectible card business is on life support but could be profitable with some changes. I can't believe Arthur Shorin would want to stay public under Sarbanes-Oxley regulations, unless the rules are changed.

Pembridge did not file 13D during the 2005 proxy process, when it owned 110,787 shares.

Board of Directors
Stephen Greenberg Allen & Co., LLC
Jack Nusbaum Willkie Farr & Gallagher LLP
Edward Miller ex-AXA Financial and Chase Manhattan
Arthur Shorin
Ann Kirschner
Richard Tarlow
Allen Feder
David Mauer

Other: President & COO Scott Silverstein is Shorin’s son-in-law. General Counsel Warren Friss is a friend of Silverstein’s.


Potential catalysts include:
 cost-cutting opportunities inherent in a paternalistic corporate culture with approximately $76 million of unallocated general and administrative expenses (25.7% of sales; allocated G&A represents another 8.4% of sales);
 the emergence of an activist investor seeking the sale of the company, the spin-off or sale of one of the two businesses or more aggressive share repurchases; there is no poison pill and Chairman and CEO Arthur Shorin stands for re-election on June 30th;
 baseball card revenue and profit growth resulting from a change in industry structure that eliminated two of four competitors; and
 the appearance of a hit entertainment product; it should be noted that the recent re-introduction of Wacky Packages could add $25 million to sales at a 35% margin (margins are higher because there is no licensing fee) by Shorin’s estimate; in 1974 they added more than $100 million in sales.
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