Pat McKeough recently replied to a question from an Inner CircleMember about a Canadian company that markets some of the world’s most famous toys and games. Spin Master began trading in 2015 and has since made five acquisitions. That helped drive up revenue and sales and boost the company’s shares. But this new issue looks particularly risky, says Pat, who adds that the company’s dependence on three big retail clients could pose problems in the future.
Q: Pat: I have a friend touting this stock to me. He is a fan of growth stocks. What is your take on Spin Master?
A: SPIN MASTER CORP. (symbol TOY on Toronto; www.spinmaster.com) designs and markets children’s toys, games and puzzles. It outsources the manufacturing to third parties. It is gaining on American firms Mattel Inc. and Hasbro Inc. and Denmark’s LEGO A/S among the world’s largest toy companies.
The company’s most popular toys include action figures and other toys based on its Paw Patrol animated TV series; Air Hogs remote control cars and planes; Meccano building kits; and Spy Gear walkie-talkies. In addition, Spin Master sells toys and games featuring content that it licenses from major entertainment studios such as Disney, Warner Bros. and DreamWorks. These include toys based on Star Wars, Batman v Superman, Angry Birds and How to Train Your Dragon.
The company sells its products through retailers in over 60 countries. However, sales outside of North America account for just 30% of its overall revenue.
Spin Master originally began operating in 1994. It first sold subordinate voting shares (one vote per share) to the public and began trading on the Toronto exchange on June 30, 2015, at $18.00 a share. Insiders control 97.7% of the voting power through multiple voting shares (10 votes per share).
The company’s revenue jumped 73.3%, from $507.5 million in 2013 to $879.4 million in 2015 (all amounts except share price and market cap in U.S. dollars). That growth is largely due to acquisitions. For example, in October 2015, the company paid $50 million for Cardinal Industries. Thanks to the purchase, Spin Master is now North America’s second-largest maker of puzzles and games. Revenue rose further to $1.2 billion in 2016.
Excluding unusual items, earnings soared from $0.23 a share (or a total of $22.8 million) in 2013 to $1.04 a share (or $98.6 million) in 2015. Earnings moved higher in 2016, to $1.19 a share ($120.1 million).
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In February 2016, Spin Master paid $11.1 million for the famous Etch A Sketch and Doodle Sketch toy brands. It later purchased Toca Boca, a Swedish toymaker, for $30.8 million.
In August 2016, Spin Master announced its fifth acquisition since it became a public company: Swimways Corp., purchased for $85 million. That firm makes a wide variety of swimming pool-related toys and equipment such as floats, beach balls and goggles. The purchase should add $90 million to the company’s annual revenue.
Thanks to those new operations, Spin Master’s revenue in the three months ended March 31, 2017, rose 40.8%, to $227.7 million from $161.7 million a year earlier. (All figures except share price and market cap in U.S. dollars.) Excluding one-time items, earnings rose 2.0%, to $10.1 million from $9.9 million. Due to more shares outstanding to pay for acquisitions, per-share earnings were unchanged at $0.10.
The company ended the quarter with cash of $95.0 million, or $0.93 a share. Its total debt of $143.7 million U.S. is a low 5% of its market cap. Goodwill and intangible assets now total $229.6 million.
Thanks to expanding sales, Spin Master shares have continued to move up this year. The stock has risen from $18 in February 2016 to the current $38.59. It now trades at 22.2 times the $1.34 U.S. a share the company will likely earn for 2017. That’s somewhat above average. However, we are more concerned about the number and variety of Spin Master’s more essential drawbacks.
To begin, we are generally wary of investing in relatively new issues for the first year or two since they usually come to market when it’s a good time for insiders or the company to sell, and that may be a bad time for you to buy. We also are wary of investing in a company’s subordinate voting shares when insiders hold virtually all the voting rights; that’s the case here. We also see inherent risk in growth by acquisition.
Spin Master has a good product line now, but toy fashions change quickly, and buyers are notoriously fickle. To top it off, three major retailers—Wal-Mart, Target and Toys “R” Us—together account for nearly 60% of the company’s revenue. As the appeal of its products falls, all three retailers are likely to demand deep price discounts.
Spin Master Corp. has built up some rising momentum and may have further gains ahead.
Inner Circle recommendation: We don’t recommend the stock. We do see it as okay to hold, but for highly aggressive investors only.
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