Dueling Fools

Dueling Fools
Is Hasbro a Has Been?
May 19, 1999

Hasbro Bull Argument
Louis Corrigan (tmfseymor@aol.com)

A great consumer company is built, in part, on great consumer brands. How about Monopoly, Trivial Pursuit, Tonka, G.I. Joe, Scrabble, Yahtzee, Nerf, Mr. Potato Head, and Barney? Or, let's try Furbys, Teletubbies, and Pokemon.

Toy maker Hasbro (AMEX: HAS) owns or licenses all of these brands, among a bunch of others. Did you know, for example, that pro wrestling is more popular with teenage boys than NFL football? Well, Hasbro has the rights to make World Championship Wrestling action figures. Did you know that NASCAR has the fastest-growing fan base of any sport in America? Well Hasbro produces a line of NASCAR-themed electronic games.

And I'm sure you've heard of the Star Wars prequel, The Phantom Menace. Hasbro has exclusive rights to produce virtually all of the toys related to the film. It's offering a full line of action figures, including some that actually speak lines from the film. While Star Wars has generated some $4.5 billion in merchandise sales over the last 20 years, analysts think Hasbro could capture a good part of the $1 billion that will probably be spent this year on Phantom merchandise, and as much as $5 billion to $6 billion over the next decade.

However, the toy business has seen some hard times lately. Giant retailer Toys "R" Us (NYSE: TOY) lost ground to Wal-Mart (NYSE: WMT) and was forced to close stores and rethink its merchandising approach. In the process, it slashed inventories per store, putting a major dent in 1998 sales for major toy makers Hasbro and arch rival Mattel (NYSE: MAT). Meanwhile, would-be blockbuster movies with toy tie-ins have flopped (think Godzilla). At the same time, kids, especially girls, are graduating from dolls to electronic games one or two years earlier than in the recent past. Because of these changes, wholesale toy shipments were essentially flat last year at $15.2 billion.

These industry shifts, however, reinforce Hasbro's growing competitive advantages. To prosper in this market, a firm needs more than a hot product; it needs marketing and distribution strength. That's one reason Tiger Electronics, makers of Furby, opted to be acquired by Hasbro in February 1998. Hasbro had the resources for Tiger to really capitalize on the Furby.

Indeed, just as major Hollywood studios license rights to literary works or acquire promising independent films for distribution, Hasbro has positioned itself to attract the hot products or brands it needs, no matter who produces them. Hasbro's recent press releases reveal the trend. Nickelodeon, for example, has signed a three-year licensing deal for Hasbro to market interactive games based on the popular CatDog and Nicktoons animation series. Hasbro also recently acquired from Namco Ltd. the rights to 11 properties, including arcade classics like Pac-Man.

This move toward licensing reflects the way that Hasbro has rethought its approach to the market. "Hasbro now no longer thinks of itself as a toy company," CEO Alan Hassenfeld told the Wall Street Journal a month ago. "We're more than that. We're a library of brands."

Part of that means making the most of the brands it already has. Along those lines, it signed a licensing deal that's allowed WMS Industries (NYSE: WMS) to create a hot slot machine based on the classic board game Monopoly. Hasbro is also looking beyond inventing the next hot toy. It now aims to acquire rights to those brands, old and new, that it can market successfully. The company has gone on a shopping spree in the last year. In addition to electronics toy maker Tiger, it's purchased software games maker MicroProse, Star Wars licensee Galoob, and old arcade king Atari. The cheap Atari purchase has already paid off in an updated version of Atari's Frogger, the arcade classic, which recently topped the list of action video games.

The company's transformation has also involved reducing head count and relying more on less expensive manufacturing overseas. In the fourth quarter of 1997, Hasbro took a $125 million charge to cut 20% of it workforce, close plants and streamline operations.

All of this has paid off, as Hasbro is now threatening to surpass Mattel as the top toy maker. First quarter revenues hit hyperdrive, zooming ahead 38% to $668.4 million, thanks largely to the Tiger Electronics acquisition. Net income rose 77% to $13.8 million, with EPS up 75% to $0.07, or two cents per share above estimates.

The deal-making has led to an 83% jump in amortization charges to $26 million. The company also added $410 million in low-interest (5.6% to 6.6%) long-term debt to finance these deals and to repurchase 1.7 million shares during the period (paying $26.47 a piece). While these were smart moves, they bumped up first quarter interest expenses by 420% to $12 million. However, this means EBITDA (earnings before interest, taxes, and depreciation) actually increased by an even stronger 91% to $75.8 million.

The balance sheet also remains solid. Inventories rose just 31.5% year-over-year, or less than sales, which is good. Accounts receivables (AR) were up 43%, well ahead of sales, but they're basically flat with the Q1 FY97 number. With the Toys "R" Us inventory reductions a year ago, the AR number for Q1 1998 was just unusually low.

Hasbro's trailing 12-month results, excluding charges associated with the acquisition of MicroProse, look like this: revenues $3,490 million; net income of $226 million; EPS $1.10. So at $32 1/2, Hasbro trades for 22 times the high-side FY99 estimate of $1.47 per share. Meanwhile, it carries an enterprise value (market cap minus cash net of debt) of $6,843 million, or just shy of 2x sales. That's certainly not expensive for a company with a 6.5% net profit margin and expectations for a banner year. Plus, Hasbro has positioned itself to remain among the top two toy makers in the world. It could actually pull well ahead of Mattel if Phantom proves a smash hit.

Of course, given its huge licensing pact with George Lucas (which I'm sure Rick will mention), Hasbro has a lot riding on the success of Phantom. Initial reviews have been mixed, with many critics complaining that the film plays young, is slow in spots, and loses the characters in the special effects. Sounds a lot like the original Star Wars! Hasbro shares have been volatile in recent weeks as the excitement ebbs and flows. Still, given the "installed base" of fans, I think the film would have to be a real flop for the toy sales to disappoint.

If you buy around the current price, Hasbro should deliver market-beating returns over the next five years. The company has reinvented itself and is leading its industry out of a slump. Though the stock has risen 36% already this year, Hasbro still sports a below market multiple. For a firm with a host of well- known brands and key competitive positioning, that's surprising.

Next: The Bear Argument