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Daily Trouble
November 2, 1999

Hasbro Inc.

Ticker: (NYSE: HAS)
Phone: 401-431-8697
Website: www.hasbro.com
Price (11/1/99): $20 3/8

By Rick Aristotle Munarriz (TMF Edible)

How Did it Find Trouble?

Hasbro had it all. Its Furby was the hit of the 1998 holiday season, and Pokemon was beginning to bubble hot. With a ten-year licensing pact signed with George Lucas just as The Phantom Menace was gearing up for its theatrical release, it felt as if the Skywalker was the limit for Hasbro.

With more homeruns in its portfolio than Hank Aaron taking Khoury League batting practice, it seemed as if there was little left to go around for its competitors. It was a classic case of the HAS and the HAS nots.

Unfortunately, euphoria shot past the fundamentals like young Anakin in a adrenaline-powered pod racer. By the time investors had digested the prospects of a Star Wars deal that would probably ring up close to $5 billion in retail sales over the next ten years, the shares had peaked at $37.

Then the pod hit reverse. Wall Street was no longer impressed with the sales tally of Darth Maul action figures. Instead it began to ponder the generous 20% royalty the company would have to shell out to Lucas. The health of the industry, which had masked its weakness through aggressive acquisitions in the past, began to show its ailing ways. Industry giant Mattel (NYSE: MAT) reported dismal results. While Mattel's demise stemmed from losses at the Learning Company, which it had acquired back in March, Hasbro too had gone to the software merger altar with MicroProse.

Hasbro would go on to report healthy earnings, unlike its teetering peer. But once the Star Wars halo effect subsided, and the industry lure vanished like an old Jedi master trick, only those speaking in Furbyish gibberish were around to fly Hasbro colors.

Business Description

As the world's second largest toymaker, closing in fast on Mattel for the pole position, Hasbro produces a wide range of toys, games, and software. The company's product line includes Kenner, Playskool, Tonka, Milton Bradley, Parker Brothers, Galoob, and Tiger Electronics.

In September the company closed on its acquisition of Wizards of the Coast, the company behind the popular Magic and Pokemon card games.

Financial Facts

Income Statement
12-month sales: $3,945 million
12-month income: $263.1 million*
12-month EPS: $1.28*
Profit Margin: 6.7%
Market Cap: $4081.1 million
(*Excludes one-time charges)

Balance Sheet
Cash and Equivalents: $108.6 million
Current Assets: $2,267 million
Current Liabilities: $1,839 million
Long-term Debt: $407.6 million

Price-to-earnings: 15.9
Price-to-sales: 1.03

How Could You Have Seen it Coming?

Since its 1977 release, Star Wars has redefined the realm of celluloid merchandising. More than 250 million action figures have been sold and, in sum, $4.5 billion in retail sales have been generated from Lucas' licensing deals.

But why did Hasbro's shares get bid up so high? Even if the company nailed the billion dollars in projected Star Wars sales over the course of the year after Phantom, that would still only account for just a quarter of Hasbro's trailing sales.

Unfortunately for Hasbro, after yielding the big royalty cut to Lucas, it wouldn't have been a major boost to profit margins. That is the problem with licensing deals. While licensing has helped Hasbro line up toy deals for the likes of Teletubbies, WCW, Pokemon, and Star Wars, those items have thinner margins than the proprietary playthings. That is why, until the recent Learning Company debacle, Mattel and its own Barbie and Hot Wheels lines produced higher net margins than Hasbro.

Another problem with licensing is that it is often done in the pursuit of faddish properties. Remember the four Teletubbies? In the closeout bin they're all Po folks now.

So, while Hasbro had plenty going for it, like its timeless Parker Brothers board games, investors were chasing it for the wrong reason -- and to a price that would be hard-pressed to justify itself based on the licensing financials and fundamentals.

Where to From Here?

Earnings for Hasbro are up 49% this year. That is healthy, but it also is coming off of a weak 1998 that couldn't even top 1993's operating profits. The road ahead is more telling. Projections on Hasbro's bottom line have been weakening, and now Wall Street expects just 9% earnings growth next year.

Yet, at these lower price levels, Hasbro is definitely worth a closer look. The company thinks so anyway -- over the past two years it has bought back $400 million worth of its own stock at an average price of just above $25 a share.

While Mattel's software problems have sandbagged performance in Barbieland, Hasbro Interactive is doing just fine. Personally I haven't enjoyed a new game as much as Hasbro's Roller Coaster Tycoon in years. But, beyond that, the company is merging new technology with nostalgia. It succeeded in its Frogger and Centipede updates, now Pong and Q*Bert will also get high-tech makeovers.

Wizards of the Coast was a great purchase for Hasbro. The company's Magic card game has been a hit with young adults for a while, and now the Pokemon trading frenzy is hitting feverish levels with the younger set -- and a Pokemon movie opens next week). Will Wall Street hype up Hasbro for the Pokemon angle the way it did for Star Wars? If so it might mean another short-term ride to the stars -- but don't let the greed of the dark side win you over this time too.

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