Funko, is a cyclical consumer retail company that is in the business of licensing content to create products such as plush toys, action figures, accessories all the way through to branded t-shirts. The company leverages their own distinct designs and creativity in conjunction with licensed content. The business strategy is similar in nature to Lego, whereby proprietary and distinct Lego block design is married with licensed content from Lucasfilm, Marvel, Disney, etc. The company has licensed over 1000 properties and has significant retail channels including Amazon, Barnes and Nobel, Gamestop, Walmart, etc.
On November 1st, 2017 the company priced a 10.6 million share offering at $12.00 per share and IPO’d a day later, closing at $7.07 or 41% lower than the offering price. A cold reception for Funko shares but is it warranted?
The financials paint two different stories, one of medium term growth and in our opinion a much more concerning trend of decline in the more recent term. Let’s start with the positive.
Due to a corporate acquisition that took place in 2015, Funko has broken down the income statement results over two periods before and after the acquisition. For comparative purposes, we’ve combined the results.
The 2016 year-end income statement shows robust growth both on the top and bottom lines with increase of 56% and 125% respectively and an added increase in the company’s profit margins.
This growth story gets pretty grey as the most recent quarters ending Mar 31st and Jun 30th, 2017 show a precipitous decline in revenue and net income.
It’s hard to consider this an outlier in performance considering that the performance get’s progressively worse.
A recent article (https://www.bloomberg.com/gadfly/articles/2017-11-02/funko-ipo-maker-of-dolls-extends-playtime-to-accounting) published on Bloomberg states that Funko’s growth calculations may have been misrepresented in it’s prospectus filing which has led to a formal investigation by the law firm Kirby McInerney LLP.
Search interest in the United States for “Funko” shows exponential growth over the last five years. However, we’re more interested in search interest in the products/designs that the company sells. The company has a number of proprietary designs that have a “passionate following” according to their SEC S-1 Filings:
Pop! ®, Mystery Minis®, Dorbz®, Pint Size Heroes™, Rock Candy®, Galactic Plushies™, Hero Plushies™, SuperCute™ and MyMoji
‘Mystery Minis’ and ‘Dorbz’ were the most searched designs while the remainder of their designs barely registered in comparison. We focus in on the United States as the market there constitutes 71.4% of 2017 net sales:
We can see a clear turning point for searches in July 2016, at which point interest falls precipitously with no signs of reversal. Removing searches for Mystery Minis and Dorbz, we can clearly see that the same negative trend has formed in their other designs:
In the consumer retail space, it’s normal for consumer choices to change rapidly, especially in the retail segment; Funko appears to be experiencing this first hand. Waning and in some cases, stagnant search interest in the company’s designs raise red flags in that the company should be dedicating more of its efforts to improve its design pipeline versus allocating additional resources to international expansion. This presumption is further supported by the fact that top and bottom line have fallen over the previous two consecutive quarters. We’re inclined to stay away from taking a position in the company unless of course search interest and public sentiment towards the design pipeline improves in a meaningful way.