Playmates Toys Business

Source : Google Finance

If you have ever seen the movies and cartoons related to Teenage Mutant Ninja Turtles, you would have probably seen the toys that are produced by Playmates Toys Ltd(Stock Code :0869) listed in Hong Kong. In the normal course of business, the company enters into contractual licensing agreements to secure its rights to design, develop, market and distribute certain toys and family entertainment activity products for future sales. Their sales occurs mostly towards the year end, presumably towards Christmas and hence, receivables tend to balloon towards the year end. With a current market capitalization of HK$501 million and dividends that were skipped in 2018, the share price of playmates has fallen quite drastically over the years, prompting me to examine the company further.

Source : aastocks.com

Perhaps an all too brief history of the company is necessary to understand the economics of the business. We shall examine its operating performance from 2006 to 2012.

2006 – 2012 Operating Performance of Playmates Toys Ltd

Between 2006 to 2012,  Playmates Toys had an operating history in which it seemed as if the company had everything going wrong for it. The company was predominantly swimming in losses. In 2006, its operating income was approximately HK$28 million. And after that, it went downhill from there.

Items\FY2006200720082009201020112012
Revenue1128.0909.0703.6636.4148.244.9371.6
Selling, General, & Admin. Expense513.2459.9408.2325.2152.199.2171.8
Operating Income28.0-53.8-138.7-33.2-90.0-86.352.2

Numbers in Millions of HKD

In 2007, Playmates Holdings Ltd(Stock Code:635)  completed a spin-off of Playmates Toys Ltd and Playmates Toys Ltd(00869) began trading on the Hong Kong Stock Exchange. It was perhaps an opportune time to be listed. Access to capital markets and increased standing with its clients due to its public listed status gave it more credibility. 

But the following 4 years was painful. The company endured 4 successive years of lower revenues. Even before the subprime financial crisis hit, the toy industry was hit earlier than most industries such as financial services and industrial companies. A large part of those losses can be attributable to management decisions which are far from scrutable through the eyes of the ordinary investor. The brands and rights that it decides to license and acquire determine a large part of the company’s success. Also, the company remains extremely dependent on the US market, with the majority of the revenues coming from the USA.

On hindsight, the decision to list may have proved a shrewd one on the part of management, namely Thomas Chan and Robert Lou as Playmates continued to battle a deteriorating business which was not sufficiently disclosed as Q4 2007  turned in a disastrous performance leading to a net loss of HK$34 million in FY 2007.

The parent company, Playmates Holdings Ltd was however more resilient. It was a consistent dividend payer and generated predominantly positive operating cash flows which funded the dividend outflows. So in a sense, Playmates Toys Ltd was a shell in which to execute its toy business, which was rather cyclical in nature.

Some Risks To Consider

Toys & Selected Brands May Not Be Successful

Source : 2009 Annual Report 

From 2006 to 2012, the company had 6 successive years of falling revenue and losses. For the sake of contrast, it had $1.1 billion in revenue in 2007 despite an industry-wide recall of toys over safety concerns. Then, toys were sprayed with leaded paint and fixed with detachable magnetic parts thought to dangerous for children. By 2014, the revenues were just $44 million. Certainly, it can get worse before it can get better. The revenues obtained in FY 2018 was $474 million. Looking back historically, there is some vulnerability in its toy business.

Apart from that, the movies and cartoons may not generate sufficient interest in its toys. This is evident from a short snippet from the 2009 annual report reproduced above. Also, there is a limit to operational cost control. If the toys cannot sell, its shareholders are pretty much done for. That explains a large part of the underperformance in the business from 2006 to 2012.

Only A Few Brands & Customers Make Up The Bulk Of Its Revenue

Source : Annual Report

Another major issue of the toy business is that the company is highly dependent on a few customers. In fact, 67% of the sales that the company generated is derived from the 5 largest customers that it does business with. There is a huge dearth of information with regards to who the customers are. And because retailers around the world are undergoing an enormous amount of strain currently, this is not good for Playmates Toys Ltd in general.

Dividends May Not Be Resumed Soon

While the company sits on a lot of cash, it remains to be seen if the company would resume dividends soon. For one, the company’s vulnerability in recessionary years seem to indicate that things can get quite bad. And as such, management attempts to conserve that capital for a rainy day by not paying dividends. In 2018, the company skipped paying its dividends.

A Cash Bargain

Based on the unaudited 30th  June 2019 cash balances, the company had 1.1 billion in cash and cash equivalents and about $200 million in total liabilities. The company has a market capitalization of just $507 million which means that the company is a bona fide cash bargain where  the market capitalization of the company is less than the resultant value of the cash and cash equivalents less all liabilities. By all measures, it is a deep value stock where the net cash per share, net of all liabilities and minority interest is equal to $0.67.

Playmates Holdings Ltd

Now of course, going down the rabbit hole on this was mandatory. The parent company of Playmates Toys Ltd was Playmates Holdings Ltd. And the balance sheet and businesses of Playmates Holdings Ltd was a lot more resilient than that of Playmates Toys Ltd.

Source : aastocks.com

The dividends given by Playmates Holdings are still respectable. While the aggregate dividends given in FY 2017, FY 2018 and FY 2019 are lesser than the prior three fiscal years, the company is able to afford doing so due to the cash flows generated from its property investments.

I am going to reproduce here the segment profits of Playmates Holdings Ltd and the estimated free cash flows.

Segment Profit Before Tax Excluding Revaluation Gain/Loss On Investment Properties

Year2012201320142015201620172018
Property Investments & Associated Businesses35.8121.1138.2156.7170.5169.5170.9
Investment Business38.6-1.95.3-11.210.634.88.4
Toy Business45.8539.7636390176.188.54.4

Numbers in Millions

Free Cash Flows

Year20092010201120122013
Free Cash Flows-207.558.5-42.9115.4414
Year20142015201620172018
Free Cash Flows504.1333.1398.9251.5172.3

A basic valuation of the company will be performed here. The company’s cyclicality is affected predominantly by the toy business. As such, it would be prudent to average those cash flow out over 10 years or more. We will look at 10 years of free cash flows and think about valuing these cash flows as a perpetuity. There will be no growth assumptions in place for the sake of conservatism.

Average Free Cash Flows Over 10 years = $199.74 million

199.74/0.08 +  = 2496.75 million

Surplus cash, considering the median net working capital needed as a percentage of sales, is estimated to be around $550 million. And so if we add that to the value of the cash flow stream above, we get an intrinsic value of around $3046.75 million. This value is above the current market capitalization of $2.48 billion. But of course, valuations change according to the assumptions. And there are many things that could go wrong. The surplus cash could be whittled away quite easily in the hands of management who are reckless. Also, do bear in mind that while the price to tangible book value is 0.37 currently at a price of $1.18, the price to tangible book ratio fell to a low of 0.13 in the throes of the subprime financial crisis in 2008-2009. Hence, a subjective dose of scepticism and probabilistic thinking should be employed by investors in these uncertain times. For example, Playmates Toys could see some tough times ahead. Since the Playmates Holdings is the parent company, there is a possibility that the parent company may be forced to bail out the Playmates Toys in times of need. Perhaps that is why it is keeping that much excess cash on its balance sheet. After all, Playmates Toys had a cumulative approximate value of $400 million in operating losses over 6 years from 2007 to 2011.

What The Company Should Do

The company is not in the business of managing investments. As such, it should liquidate its investment portfolio and return it to investors. This value amounts to $86.8 million

The amount of working capital needed for its operations is probably excessive at this point. We are talking about net working capital as a percentage of sales tending close to 150% for FY 2019. The median net working capital as a percentage of sales was just 46% while the average was 53%. So the management ought to consider the distribution of this excess capital to the shareholders.

Corporate Governance Matters

There are other matters to consider when  an examination is made of these 2 companies. Corporate governance disclosures are not exactly world class. For more, see  the link below.

https://www.hkex.com.hk/news/news-release/2011/111207news?sc_lang=en

Conclusion

There is a truckload of uncertainty in today’s markets. The unresolved trade war between China and Iran, the spike of oil prices due to tensions between Iran and the US caused by the assasination of Qassem Soleimani, the incessant Hong Kong protests and a whole host of other issues.

But of course, investors should focus on understanding the companies and assessing their intrinsic values. For now, I will leave these 2 companies in a watch list and track the developments. For investors out there and myself as well, we always have to weigh not just the pros, the cons, the valuation metrics, but  also the opportunity costs associated with making any investment.


kingsley

I have been an investor for 15 years now and my journey has meandered from Warren Buffett to Ben Graham. My start, like many, really was the naive idea that Buffett's skills could be replicated in some fashion. I was proven wrong when some of the supposed stock picks that I chose had dismal performances. Then, I learnt that it is no point trying to be someone I am not. Gradually, through failure and some success in deep value investing, my approach towards stocks gradually shifted to an approach based around Graham's techniques. So, I give credit where credit is due and to Ben Graham, I and many other investors around the world, owe him a great deal. So, if you want to read up on biographies, read about Ben Graham. His seminal work, Security Analysis is a gem. My books are just rich interpretations of what he has taught.

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