MFAIF - Leaven Partners - Playmates Toys: Once A Screaming Deal

2023-10-19 09:15:00 ET

Summary

• Playmates Toys, a Hong Kong-based toy manufacturer, has experienced financial difficulties due to the COVID-19 pandemic.
• Despite the challenges, Playmates has diversified its licensing agreements and has a history of treating shareholders fairly.
• The company has returned to profitability, doubling revenue in 2021, and recently released new toys based on the Teenage Mutant Ninja Turtles franchise.

The following segment was excerpted from this fund letter.

Playmates Toys Ltd ( OTCPK:PMTYF )

In the quarter, I sold out of one position in the fund: Playmates Toys Ltd ( OTCPK:PMTYF , 0869.HK ). Founded in 1966 and based in Hong Kong, Playmates Toys has been in the business of manufacturing and selling toys primarily to American and European children since the 1970s.

After selling dolls for over a decade, the company hit paydirt in the late 1980s when it decided to manufacture action toys for a new cartoon series called Teenage Mutant Ninja Turtles (TMNT). Having the foresight to obtain exclusive licensing rights to the brand, Playmates has enjoyed the multi-decade run of an iconic brand. To offset lost revenue when the TMNT franchise periodically laid dormant, Playmates diversified into many other licensing agreements with franchises, such as Godzilla vs. Kong , Star Trek , and the recent Netflix hit, Miraculous: Tales of Ladybug & Cat Noir , (which is also a major hit with my children!).

I first took note of the company in late 2019 after the company reported poor operating results with the stock price headed in the wrong direction. Then COVID-19 hit. Needless to say, no one was going out to the movies or buying toys. Compounding the problem was that the TMNT brand was in a planned hiatus (with no scheduled toy releases) and there was nothing else to pick up the slack, including the much-anticipated Godzilla vs Kong movie release that was now delayed until 2021. In August 2020, Playmates reported dreadful semi-annual results and posted an operating loss of over -$6 million ^[1] —its worst half-year result in nearly a decade. I built a material position ^[2] in the stock at an average cost of HK$0.254 per share.

Although I typically do not jump at the chance to buy a money-losing enterprise, there were a few factors that led me to do so.

First, the financial difficulties were caused primarily by an exogenous shock that I did not perceive to be indefinite. In similar logic to our holding in Ming Fai International Holdings Ltd ( OTC:MFAIF , 3828.HK ), I did not anticipate a change in their business post-COVID: things would go back to normal. At the end of the day, Godzilla vs Kong would eventually hit the big screen and kids would want the action figures.

Second, Playmates had licensing agreements in place. I felt reasonably comfortable that, when things got back to normal, there would still be toys to make.

Third, even with the wheels coming off during the Covid pandemic, in 18 months Playmates had only burned through a little over $10 million. At the time, Playmates had $125 million in the bank with practically no debt. In addition, Playmates subcontracts out the manufacturing of the toys, so its cost structure is quite variable. In other words, it had greater flexibility to batten down the hatches, weather the storm, and conserve cash. Although I did not know how long the COVID pandemic would last, I felt comfortable knowing Playmates would outlast it!

Fourth, the company has had a history of treating its shareholders fairly. And, lastly, the stock price was enticing. At our average purchase price, the company was trading for the bargain basement price of $38 million. To put that in perspective, the cumulative operating cash flow generated by the company for the previous 5 years was a little shy of $90 million. To me, at a $38 million sales price, we were getting a pretty good deal with little risk of permanent loss of capital.

Since 2020, Playmates has returned to profitability, more than doubling revenue in 2021 and generating around $14 million in combined operating cash flow in the past 30 months. Last week, Paramount Pictures released Teenage Mutant Ninja Turtles: Mutant Mayhem to positive reviews, reaping $180 million at the box office. As is customary with TMNT releases, Playmates introduced a new line of TMNT toys based on the new movie. On a lesser note, in July, Miraculous: Ladybug & Cat Noir, The Movie was released in theaters internationally and on Netflix, with Playmates supplying the accompanying toys.

The near future appears bright for Playmates, but it is hard to predict. The last major TMNT up-cycle, around the release of the 2014 Michael Bay film, saw a significant increase in sales and earnings—although it did not pan out to what analysts were forecasting at the time. In their most recent report to shareholders, management “continues to be optimistic about the second half of the year” based on the release of both movies.

Although I could easily find ways to be optimistic as well, our strategy is focused more on the value of the assets of the company rather than the expected future earnings. ^[3] Based on the liquid assets at Playmates, what was once a screaming deal has now become reasonably valued due to the appreciation in the stock price. I decided it was better to move on to another cheaply priced asset. ^[4] I sold our shares at an average price of HK$0.84 per share.

Whenever asked to prognosticate about future events, the great Benjamin Graham would respond: “The future is uncertain.”

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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