Richard Goh, June 12, 2020
This week, I wanted to analyse a company that at first glance, has a rather bleak future. Hasbro’s recent acquisition of eOne entertainment will expand its brand portfolio in the TV and film industry, while Magic: The Gathering Arena will aid its foray in the digital gaming and e-sports industry. The question is: will it be enough?
____________________Hasbro is currently trading at $71.08 as of 12 June
This week, I wanted to analyze a company that at first glance, has a rather bleak future.
Hasbro has long been associated with its repertoire of board games and toys, but these days, consumers are more driven to computers and consoles for their entertainment fix. I wrote an article two months ago about investing in Activision Blizzard because of the anticipated increase in customers due to stay-at-home measures. Its shares have risen 23% since then.
Hasbro, on the other hand, has climbed a modest 7% in that same timeframe. Even though more families are stuck at home, fulfilling the demand for toys and board games is difficult when the company’s supply chains have been disrupted and retail stores are shut down. Revenue growth dropped by 7.5% for Q1 2020 as compared to Q1 2019 and the company suffered a net loss of $0.51 per diluted share compared to a net earning of $0.56 in 2019.
As we enter a new decade, Hasbro must learn to navigate the digital landscape and rival console and PC gaming. These companies incur smaller operating expenses because the cost of goods is low, allowing for the reinvestment of profits into R&D projects. Hasbro’s recent acquisition of eOne entertainment will expand its brand portfolio in the TV and film industry, while Magic: The Gathering Arena will aid its foray in the digital gaming and e-sports industry. The question is: will it be enough?
DCF Model
Hasbro’s financial results before 2020 did not contain its eOne acquisition on Dec 30. Subsequent years’ revenue includes this, hence the 23.6% jump in gross revenue from 2019 to 2020. Revenue growth was forecasted based on the weighted combination of Hasbro and eOne (recorded as TV, Films and Entertainment) segments prior to the acquisition. COGS and operating expenses as a margin of Hasbro’s revenues were also adjusted accordingly because the eOne film and entertainment segments have a significantly lower profitability than Hasbro’s other segments.
A few key assumptions were made. Most films scheduled for screening in 2020 were ultimately delayed because of COVID-19. Thus, we anticipated revenue to decline in 2020 for Hasbro’s ‘Partner Brands’ and ‘TV, Films and Entertainment’ segments. A decline in 10% was chosen based on the Q1 Earnings Report released by Hasbro. However, we anticipated ‘Hasbro Gaming’, the portfolio which contains most of the company’s board games, to have strong revenue growth in 2020 because of stay-at-home measures. From 2021 to 2024, ‘Franchise Brands’ and ‘Emerging Brands’ are expected to have the most growth. The company’s foray into the digital gaming industry is concentrated in these parts of its portfolio with Magic: The Gathering Arena’s growth expected to mirror that of Blizzard’s Hearthstone.
Our DCF model arrived at the following conclusion. Using a sensitivity analysis to test for changes in the company’s discount rate and terminal growth rate, we reached a likely range between $84 to $103 – representing a target upside of between 11% to 35%.
Comparables Analysis
Using key financial metrics from its competitors was more pessimistic. We reached a target price of $54 - $67 based on EV/EBITDA and EV/EBIT multiples suggesting that Hasbro is currently overvalued.
Why the huge difference in valuation? Because Hasbro is currently operating in a unique position: halfway between traditional toymakers like Mattel and video game / digital entertainment companies like Activision Blizzard. Traditional toymakers have much lower EV-to-EBITDA ratios but are far less profitable when you consider their net income. Conversely, companies like Blizzard have huge market capitalization riding on the hopes that revenue and earnings will continue to grow in the future, reaping gains for investors.
On that note, buying Hasbro stock now will be a risky investment unless investors believe it can buck the trend of traditional toymakers and grow its share in the digital entertainment industry. Another worry about Hasbro is its capital structure. Its debt-to-equity ratio is high at 1.89 whereas for most digital entertainment companies, they are largely financed by equity. This means that more of the future earnings would be passed on to shareholders, instead of being reduced to pay off long-term debt.
In conclusion, this week I am not advocating Hasbro as a strong buy. It remains to be seen how well the company can succeed in this new era of games and entertainment. From 2017 to 2019, it was showing signs of declining and volatile revenue that is dependent on the success of its partner shows. What bright spots that may appeal to investors is that Hasbro’s share price was above $100 in 2019, even before the eOne acquisition. Some might believe that the company has plunged already and the only way to go is up.