Funko (FNKO 0.79%) makes collectibles that adults buy. The company's average customer is 35 years old, and women make up 51% of its customers. That's encouraging, but it does not change that Funko makes 81% of its revenue from its Pop figurines. Despite the risks, the toy company has been steadily growing its sales, and that makes it a target for acquisition.

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This video was recorded on May 21, 2019.

Nick Sciple: It's going to be interesting to see how this progresses. I don't know what the right word for it is, I've heard "nerd culture" thrown around, it's becoming a bigger and bigger influence in our society today. You look at Funko, this company's been around since 1998, and for me, I only really started noticing these toys in stores maybe the past three or four years. It's really started exploding in the past few years. Again, talking to those trends, in an analyst report that Funko sent out, they called out the average age of their customer as 35 years old. To Jim's point earlier, 51% female, which surprised me. I had the image in my mind of what Dan was talking about, of more of a nerdy masculine type of buyer.

Dan Kline: But, female, not necessarily buying it for themselves. Mom buys the birthday gifts in a general, broad, super stereotypical sense. Again, having been in a toy store, during the week, Mom comes in. Dad comes in on the weekends. There's a much better chance Dad's buying himself a model or a collectible and Mom is buying it as a gift. So, that stat's probably a little misleading.

Sciple: Yeah. Again, if you look at some of their operating metrics, net sales have been moving consistently up and to the right over the past several years. Gross profit as well. However, net income has been more or less flat the past several years. You look at this, this is a toy company trading at 53 times earnings. Again, we've shared our doubts about it being more or less a one-product company. Do either of you see a path to where this could justify this valuation? Or, is this just one of those we think is going to fizzle out?

Kline: No, Mattel's going to buy them.

Jim Gillies: I was going to say... but, the only problem is, Mattel and Hasbro, both of those have been struggling in the past little while. I follow Spin Master, which is a Canadian toy company. They have been struggling in the industry, and yet they're positive free cash flow and they're at least moving earnings in the right direction as opposed to the big two, Mattel and Hasbro, which have really struggled. I'm hard pressed to remember which one has done worse recently if I looked at all three of them, with Spin Master.

Yeah, Funko will get sold to someone. Again, if they are the Pogs 2.0, as Dan calls them, I would hope they would have the great good sense to sell before the bell tolls midnight. I have a research report up on the one screen here, and looking at some of the consensus estimates going forward, I won't bore you with numbers, but I'll summarize it as, they're dreaming in Technicolor if they think they're going to get these numbers here. Like, the net margin is going to go from 1.5% to 12% in the next three years?

Kline: They also talk a lot about diversifying their product base, but the way they talk about it, historically, has been a challenge. One of the areas they're saying is, "We have all these licenses, let's build games." Again, toy store experience, people buy games based on gameplay. There is a very limited market for Star Wars Trivial Pursuit. There is a very limited market for games set in the Harry Potter universe. It's very hard to have a sustained hit in general in games. I don't see this like very obvious pivot. Now, they could make action figures. They could do other things. But those are different licenses, they're different fees. They are like looking for the next hit in an area that -- who would have predicted the first hit? I mean, they're bobbleheads. It's a stupid product. [laughs]

Gillies: As an owner of Star Wars Trivial Pursuit, I'm going to defend that a little bit.

Kline: Me too.

Gillies: The original, not the recent one.

Kline: I have the one where R2D2 is the die.

Gillies: Is the die, yes, yes. That's the one I've got. I've got to hold it up here, that's your typical Funko. It's a squat little figurine based on whatever pop culture you're looking at. I have seen in some of the stores I've been in recently, they are trying to branch out into not bobbleheads, but almost a playable action figure. I usually look at them and go well, "That's not a Funko, that's not a Pop." I'm in agreement with Dan here. The direction they need to go...

Kline: Just to quickly wrap up, because I know we're running out of time, the one potential saving grace here, and the technology is not there yet, is if they could move to a 3D printing in-store model. The problem is the cost of that and the time. You might put in, "I want my R2D2," and then walk around the store for 10 minutes. You're not going to put it in and come back a week from Wednesday like buying glasses. So, as much as that technology is possible for one-offs. It isn't there for mass production. But if it ever is, toy stores are going to be one of the first places where you see printing of stuff like this, because it gives you inventory control. That could be a saving grace for the company, but it will be a division of somebody else by then.

Sciple: Yeah, it will be interesting to watch. One last thing to call out, you talked about acquisitions. There's still, at least from what I saw on S&P Capital IQ, over 40% of their shares are held by private equity, venture capital type of investors. Of course, those type of folks, sooner or later, are going to be looking for a liquidity event of their holdings, and obviously, selling the company would fit to that narrative as well.

We'll see how things go. I think, both of these companies, you take them together, are very interesting. You've got Funko, part of this trend toward more collectibles as being part of culture, Avengers, Star Wars, all these sorts of things. The operations of the business really are moving up and to the right in a significant way. But the valuation looks a little iffy. You compare that to a GameStop, where the operational part of the business is clearly deteriorating over time, but the valuation might look appealing on some of those metrics. Two examples of companies touching these trends, video games and collectibles, that are really becoming bigger and bigger parts of our culture, and two different sides of those trends.