The Hot Stock: Is Mattel Waiting for a Turnaround…or a Takeover? – Barron’s
If I were an investor in Mattel (MAT), I’d be pleading with the market, “stop toying with me!” Why? Last week, Mattel (MAT) tumbled 13% after reporting terrible earnings, suspending its dividend, and having its credit rating slashed by Standard & Poor’s. But today, its shares soared more than 11%, making it the best performing stock in the S&P 500 today. What gives?
Chalk it up to BMO analyst Gerrick Johnson and team, who argued in a note today that “investors can start looking at other end games” for Mattel, including a potential takeover. They explain:
At this point, we think investors can start looking at other end games, including a possible sale of the company. While its almost $3 billion worth of debt may limit the pool of financial acquirers, we think the company and its world-class brands could be valuable to another industry player or larger entertainment conglomerate. The ascendancy of LEGO, Spin Master, and MGA Entertainment as competitors to Mattel and Hasbro mean that a Hasbro (HAS)/MAT combination may no longer be held up by regulatory or anti-trust concerns. Given the world-class brands and intellectual property it owns, Mattel could be valued by an entertainment company such as Walt Disney (DIS), Viacom (VIAB), or Time Warner (TWX).
We think the five “power brands” of Barbie, Fisher-Price, Thomas & Friends, Hot Wheels, and American Girl brands alone could be worth more than $8 billion. Layer on top the value of other brands and intellectual property that is currently underutilized, like He-Man, Barney, Bob the Builder, or Polly Pocket, as well as the value of its manufacturing facilities, and we can come up with a $10 billion breakup value fairly easily (which equates to a value better than our $20 target).
We’re never fans of buying just because of takeover rumors, especially when others are warning that Mattel could be at risk of violating its debt covenants. Jefferies’ Stephanie Wissink and Ashley Helgans explain:
S&P downgraded MAT’s debt two notches to junk following the company’s massive Q3 miss. The rating change from BBB- to BB will limit Mattel’s access to the commercial paper market; the primary way MAT funds seasonality. Issuing equity/debt at current trading/leverage levels is unprecedented but the capital needs of the business are growing & immediate. Mattel currently has an open shelf and are levered over +5x total debt/EBITDA, implying limited debt capacity.
But there’s another reason to own Mattel, one that we’re more open to: For the sake of a potential turnaround. Credit Suisse’s Bhumika Gashti and Kaitlyn Korich explain:
Hasbro is currently the higher quality operator (earning higher CFROI® levels) and the market is pricing the company to maintain the elevated returns. MAT, on the other hand, is now underearning (lower CFROI levels) relative to its own history and peer HAS and the market is not pricing in much of a recovery
Based on MAT & HAS’s operating history, one could conclude that both companies should be able to generate CFROI levels between 12%-15%.
After peaking in 2013, MAT’s CFROI levels materially declined under the then new CEO Bryan Stockton as sales growth turned negative and margins deteriorated. CFROI forecasts suggest 2017 may be the trough return year. With a new CEO since Feb 2017 (Margo Georgiadis) and a renewed focus on product innovation as potential catalysts, there is potential for a turnaround that is not currently priced in.
MAT – If CFROI levels recover back to the 10 year median in 5 years, along with modest 1% asset growth, 51% upside is warranted. 70% upside is warranted if the company is awarded a 10 year window like HAS. However, if MAT is unable to recover CFROI levels from 2017 forecast levels, 16% downside is warranted.
Are you willing to place that bet?
Shares of Mattel gained 11% to $15.58 today, while Hasbro has dropped 1.7% to $95.47, Walt Disney declined 0.3% to $98.07, Viacom has fell 1.7% to $24.23, and Time Warner finished off 0.3% at $98.49.