Friday, October 6, 2017

MATTEL - Evergreen brand, selling at second hand prices




7 year lows

4.7% of portfolio, target 10%


Industry, Competitive Position

Hot Wheels, Barbie, Fisher Price are time tested brands with defensible economics. The toy industry is facing new players and the two main competitors Hasbro and Lego have been gaining market share. Trends around media led content and licensing deals have lowered long term margins for Hot Wheels and Barbie.

The company manufactures, designs and markets toy products. The end channels are retail; the current softness in consumer demand, weakness in traditional retail channels like Toys R Us have also contributed to weaker top line growth. Changing consumer preferences to story-lead brands through digital promotion and distribution (HASBRO - Transformers, Spinmaster - Paw Patrol, Lego - movies and games) have lead the companies who are growing their market share. MATTEL is clearly behind in this trend and have recognised and shifted their budgets and spending towards executing this strategy. The business has global sales with North America and Europe as their two largest markets. 2.4bn revenue from international sales in 2016.

Manufacturing is completed by both company owned and third party manufacturers. Core products are produced by the company. The company owned facilities are located in Canada, China, Indonesia, Malaysia, Mexico and Thailand. This is one of MATTEL's key advantages as competitors like HASBRO rely solely on third party manufacturers; and the lower quality in product is offset by heavy spending in advertising and licensing.

Competition has been increasing from smaller players as online platforms like AMZN allow smaller entrants to provide a wide variety of toys with limited overhead to compete at lower cost. Trends for life cycles for individual toys and products have shortened as increasing use of tablets and phones take timeshare. Children are getting 'older younger' Mattel is now competing with other categories such as electronic consumer products and video games. Channel constraints are caused by small number of toy retailers accounting for a large portion of sales.

MATTEL is a seasonal business with risks to rising inventory levels in anticipation of Q3/4 sales - any bad season would be material to profitability. Current struggles from bricks and morter retailers are leading to inventories being managed more tightly. We believe the key concerns around this holiday season's sales are contributing to price declines in the shares. The divergent view is that Holiday sales will increase y/y and remain stable over the next 3 years.

Changing preferences towards digital products is an area that Mattel must continue to progress and develop. The key call in this investment thesis is whether Mattel can both improve their efficiencies - find an innovative segment that combines digital, have a fresh concept within their current toy line, or see a reversing of current consumer trends.

The network effects for Mattel toys are weak as the interactive nature of toys are limited to family members and friends. The added effects of captivity are coming through digital enhancement of products as can be seen by youtube clips based around key toy lines. Hasbro has successfully completed this with apps and media that complement their toy ranges in Transformers/ MLP etc.

Competitive advantages

  1. Advertising and RD budget
    • 11.6% of sales spent on Advertising and Marketing ($635m)
    • The long track record of spending on promotions has a generational effect of the brand presence, one that will outlast current trends.
  2. Distribution networks
    • The distribution advantage is currently being contested, via the online channels.
    • Market perceives the risk of 3 main retailers in the US covering 39% of sales - WalMart, Toys R US, Target; however the smaller players lack the economies of scale to leverage profits from the retailers.
  3. Customer Captivity
    • Repeat transactions due to the characteristics of their their toys. One example is Hot Wheels - cheaper than rivals, great level of quality and detail, huge variety, seasonal exclusiveness. In a downturn in spending MATTEL will do relatively better than it's competitors, due to cuts in RD and Advertising budgets - that affect brand values in a scissors effect. The disadvantage that MATTEL has compared to HAS and LEGO - is that the other two names have what are essentially higher fixed costs; embedded in higher levels of spending in RD and LICENSING; both areas would take a hit during a slowdown in economic activity and their margins could decline brining them back to historical levels.

Notes on MATTEL advantages

Now let me tell you a bit about why Mattel operates manufacturing plants. Approximately 50% of our product by value is manufactured in company-operated plant and 50% with contract manufacturers. Our expertise in core products like vehicles, Fashion Dolls and figures, which are scale and standard-product architectures, means we produce them with a significant advantage. For example, die-cast cars. Our benchmark show that our product has more content and better finish and still has a 20% lower manufacturing cost than other manufacturers. MAT - Transcript: Mattel Inc Investor Day , Th 06.15.17 3:00 AM

We also have an advantage in making tools and molds in-house. We are reducing our tooling spend through improved manufacturing techniques. For example, high-speed CNC machining, automated tool handling and more frequent tool reuse. Put simply, we are good at operating large, complex plants and we use this to negotiate with external manufacturers and ensure we achieve competitive rates and terms. MAT - Transcript: Mattel Inc Investor Day , Th 06.15.17 3:00 AM

Big companies still want to work with Mattel - DC, Disney, or Tech suppliers. The research stressed that traditional boys were in transition and that embedding electronics and monetizing through a connected ecosystem was a better way forward. In the semiconductor world, due to the sheer volume, smart phones are the key technology driver. That I knew. What I began to realize was that they viewed our volumes as one massive opportunity and they were looking for a partner. MAT - Transcript: Mattel Inc Investor Day , Th 06.15.17 3:00 AM

Industry Map

The Industry has been growing ~5% per year since 2012, but MATTEL's market share has been eroded from 36.5% to 25.6%.

  • Mattel, Hasbro, Lego, Spinmaster, MGA Entertainment, JAKK, VTECH
MATTEL 2012 2013 2014 2015 2016
Market Share % 36.5 35.7 31.9 28.3 25.6
  • Licensees [Disney, Timer Warner DC comics, WWE]
  • Manufacturers, Designers, Distributors [Mattel, Hasbro, MGA, Lego]
  • Retailers [Amazon, Walmart, Toys R Us, Target]

Mattel operates in Manufacturing, Design, Distribution and has a smaller presence in Retailing.

The one segment that is growing is APEC - this segment includes China and other emerging Asian markets - the base market for China is still low - there are opportunities to grow the market here.

Without a new product line or turn around in traditional markets such as the US and Europe - we would put this company in the fading legacy player - where we would need an activist or management change (currently being enacted) to improve efficiencies. You could potentially see a selling with American Girl given the current weakness in the girl's toy's division - or a spin off the fisher price division; which has the most stable revenues.

Hasbro Notes

These are key themes that we're seeing. The first is that world's best brands are story-led. Today, we have a limited ability to launch stories globally without forfeiting some franchise economics created by compelling story-led brands. We own some but not all of the revenue and profit streams around and associated with storytelling in our brands. So by increasing our ability to tell stories, we can drive greater revenue and profits for Hasbro. HAS - Transcript: Hasbro Inc 2017 Investor Day, Fri 08.04.17 2:00 AM

We create digital content around brands, which runs on platforms like YouTube and our websites. Our roughly $535 million investment over this period in creating the ability to have consistent storytelling capabilities has driven $1 billion in incremental revenue for Hasbro and contributes to our over $6.2 billion of entertainment-driven merchandise at retail. In addition to content, we've had to build the technological platform to achieve efficiencies and support the profitable growth of our business as well as supporting our storytelling. Since 2010, we've invested close to $600 million in our systems. HAS - Transcript: Hasbro Inc 2017 Investor Day, Fri 08.04.17 2:00 AM

If you just look at YouTube alone, it's capturing a large and increasing share of kids' daily media consumption. In fact, 60% of kids 3 to 12 and an astounding 81% of kids 6 to 12 watch YouTube. So we're going to continue to produce a significant amount of digital content of all lengths for YouTube and other digital platforms. HAS - Transcript: Hasbro Inc 2017 Investor Day, Fri 08.04.17 2:00 AM

Hasbro Brands - transformers, my little pony, nerf, play-doh, magic, baby alive, hanazuki (youtube exclusive)

Weaknesses in Hasbro
All of their products are third party, majority which are located in China - 10K FY16. Controlling the quality of products will be important if there is marked weakness in the story based approach of marketing their products. Transformers is their strongest brand, MLP and Nerf are susceptible to downturns and all other legacy and challenger brands seem capped for growth. Costs of their media approach will only increase - there is increasing content coming from new up and coming media channels - NETFLIX, Apple etc - which can create kids content that will compete for the toy market, for e.g DINOTRUX Content, gaming is a fickle business susceptible to trends - it's very easy for the trend in this area and what is popular to change. Large increasing costs of licensing - this will hit margins.


Management have completely destroyed value in the past few years. The good news is that the company has recognised this and have replaced the CEO early 2017 and the CFO in OCT 2017. They have also demonstrated management change lead recovery in the late 90's.

We can examine Management ROIC trends - they have been falling since 2013 - after being stable for a few years, we are taking the divergent view that the power of the brand will recover as new management take on initiatives to roll out a digital strategy, and reduce expenses.

Measuring management's incremental returns - we will measure their performance for the last 10 years since 2006, has been -14.2% as the margin compression has accelerated.. The business has started to increase their payout ratio as they are realising that their business model hasn't been yielding the high returns of capital that it has enjoyed in the past. With the combined reinvestment of 30%, we get a -4% return compounded for 10 years - the market was pricing the company at $26 as of the FY report, but the compounded value predicted $14.60 - the price we are sitting as I write this report. Now the revenues have deteriorated further - it may be at least 2 years before the company can return to ROIC returns greater than 15%.

Management's description of the problems

In Mattel, I saw a company based on creativity with deep talent and expertise in play and a rich and scale portfolio of global iconic brands and play patterns that could be unlocked and reposition for purposeful growth. I believe in Mattel's potential, but the starting foundation does have some challenges. There are 3 execution gaps that underpin Mattel's recent performance: brand franchise management missteps across Monster High, Disney Princess and American Girl, 3 critical properties; excessive emphasis on short-term financial metrics at the expense of long-term success and limited portfolio planning for new initiatives.MAT - Transcript: Mattel Inc Investor Day , Th 06.15.17 3:00 AM

Management have pointed towards a focus in emerging markets growth - mainly China. This can be a key edge against the Hasbro branding - which culturally may have different effects from the story-first approach. This segment could be captured by the brand power of Barbie and Wheels and their distribution capabilities. The key thesis here is of higher quality beer (AmBev) and consumer sweets (Nestle) entering emerging markets (Russo); taking both years of marketing and adjustments to its products and distribution methods.

Now let me provide further details on the incremental investments supporting our primary strategies. Investment in 360-degree play systems and experiences will include: building our connected play system infrastructure; step change in our content activation; scaling IP extensions like consumer products, gaming and learning centers through innovative business models and strategic partnerships; building out our CRM capabilities and expanding our learning and development expertise. MAT - Transcript: Mattel Inc Investor Day , Th 06.15.17 3:00 AM

Barbie movie is actually coming- Barbie is a great example of the progress that we've made. Here we segmented brand contact to make more meaningful connections with each purchase decision maker: girls by age, moms and most recently, dads. This in turn is a wide-ranging strategic expansion of the scope of Barbie content, from a major presence in social media on Facebook and Instagram, to the innovative Barbie blogger and new episodic content on YouTube with Dreamtopia and the soon to be Dreamhouse Adventures. And yes, a much anticipated Barbie feature film is not in the near too distant future. MAT - Transcript: Mattel Inc Investor Day , Th 06.15.17 3:00 AM

The efficiencies are described by targets of 150-200m per year - which can be used to reinvest into 'rearchitecting the company'.

Let's just start with the low hanging fruit. Take a look at the employee count for the 3 main players in Toys.

Company Employee Count Revenue
MAT 32,000 5,450
HAS 5,400 5,000
LEGO 16,000 6,000

It is clear that Hasbro and Lego who have similar revenues - are doing more with less employees. A catalyst to the margin expansion would entail a workforce reduction of at least 20%. The fact that the management put in place in 2017 haven't indicated this as a measure - makes this company a target for activism. Hoping that the new CFO Euteneur can execute on the obvious.

MAT Q217 Earnings Call Notes
MAT FY16 10K Notes

Guidance and targets
Guidance by management was for a operating margin in excess of 15% in the long run. New management have been in place since beginning of 2017, so we should start seeing some results in 2019.

So what we really wanted to do, was share with you the vision for the future of the company and a clear target for the sort of returns that we want to deliver in terms of mid- to high single-digit revenue growth and a 15% plus operating margin. Having been here for 4 months and putting together this plan, which you can imagine and the restructuring that goes with it, there's a large number of actions that we have to put in place. And so we are not sharing any more details at this time. But as we put together all those plans, we will be putting clear demonstrative as we've shared -- as we move from reposition into the next phase, clear demonstrative growth drivers that you can track to understand our progress and know that we are right on track to accomplishing that deliverable. MAT - Transcript: Mattel Inc Investor Day , Th 06.15.17 3:00 AM


Year 2012 2013 2014 2015 2016
Revenue 6,421 6,485 6,024 5,703 5,457
Growth % 2.5 1.0 (7.1) (5.3) (4.3)
Gross Margins % 53.1 53.6 49.8 49.2 46.8
EBIT % 18.0 18.0 10.9 9.5 9.5
Net Debt (m) 174 565 1,128 1,209 1,457

Mattel's fall in revenue is due to lost market share in key areas which also leads to the promotional market leading to lower margins. We think these falling revenue numbers will normalise as Mattel completes a transitional period of approaching digital based selling and efficiencies within it's verticals. A reversal of margins to historical means would be a catalyst for re-rating of the stock price. At a rate of 5.4bn in FY2016 - the number is clearly close to the low revenue print in 2009.

Core brands have increased their sales from 2015 to 2016, and Other girls brands fall has been due to the end of the Disney princess license agreement.

Brand looks damaged in EU, US is due to lower consumer demands across channels and spending, Emerging markets are growing and positive.

Jan 2017 - saw downgrades to Mattel's Credit ~ BBB This will affect cost of capital.

Long term debt. Debt has been rising and this is a key concern as it happens late in the price cycle.

Valuation and Investment Case

Asset Power Value (AV)
The value of assets here is $10.30 per share (2Q17) - With a large portion of the value coming from 2.7bn in brand value. The brand value has been calculated using 3 years of Advertising and RD expense, which has average about 900m per year. As we expect this business to regain the moat in the next up cycle we would expect EPV > AV. This 2.7bn brand value seems conservative assuming this company can still generate 5bn per year in revenues.

Earnings Power Value (EPV)
Given that historically MAT has averaged ROIC higher than 17% (between 2003 - 2016 average was 17.4%) we assume MATTEL will regain it's economic advantages and this will be demonstrated by a return to growth in both revenues and EBIT margins stabilising at higher levels. Normalising margins are much more difficult in the lower demand, promotional environment and changes to sales channels. Margins in the past few years been as high as 18% and recently as low as 9.5%. Our normal case value is our target price - which we believe can grow with improving industry dynamics and competitive positioning.

Revenue 6,200,000
EBIT % 17
EBIT 1,054,000
tax rate % 33
Free Cash Flow 706,180
discount rate % 6.3
net debt 1,610,298
shares o/s (m) 342
EPV $28.30



Key Points

  1. Efficiencies - reduce head count
  2. Improve digital content - android and ios games, youtube content, TV and movie productions; redirect spending
  3. Improve channels - development on main page, better connection with online merchants
  4. Turnaround in margins back to historical levels 17%, and revenues increase to 6bn
  5. Reduce dividend, allocate resources to capex and paydown debt

Bull Case
We can assume that the brand will be strong enough to see the market go through another upswing in the cycle for margins and revenues stabilising at higher levels, our target being 17% margins, and 6bn in revenue. The target price for this scenario is $28.30

Bear Case
Short term sentiment and results could drive share price to 2009 lows - $10-11. I see this range as an opportunity to aggressively add to our holdings. A cut in dividends is likely if Q3 and Q4 sales continue trend lower; this will also add pressure to the stock price. Continued margin weakness going into Q3 and Q417. Channels continued to struggle (Toys R Us), Further weakness in Girls division, American Girl and Monster High.


ft - why hasbro and mattel share sare telling two different stories

ft - Alibaba buys into retail stores strategy

ft - Mattel's updated Thingmaker

MW - Insider buys

WSJ - Mattel Executive Revamp