Hasbro: Killing Their Cash Cow
I haven’t been writing much recently due to being on holidays in Europe, however when I saw the recent Hasbro and D&D drama I had to look into it. I believe I’m somewhat uniquely positioned as and avid D&D player and fan and casual MtG player who falls into both camps of fan and potential investor. In fact, my first substack host was writing up Hasbro as a speculative long presenting the opportunity they have to better monetise their D&D assets. The narrative I presented in that pitch has now been proven dead wrong and for me personally has flipped in the other direction. I decided to make this into a short report, as I love shorting in general and want to improve, believe that there is certainly a solid pitch to be made and believe I have a somewhat unique insight into the company amongst investors. Please take this with a grain of salt as it is an area I’m pretty new to and I would love feedback of any kind.
I believe recent developments within the DND and MOTG communities leads Hasbro to be a good short at this price. I don’t believe most investors understand the extent and repercussions of the current OGL drama, I don't believe management actually have a grasp on how to move forward with their WOTC (Wizards of the Coast) products and this is all occurring in a tough macro context coming off difficult comps. Based on valuation and management rhetoric the stock currently looks cheap, however I have little trust in management and believe earnings to be at risk in the short term. I believe with cheap borrow this is an interesting short, or even a pair trade with a long Mattel position. At the very least I believe it should be stayed away from as a long idea.
Background
Hasbro is a major US toy brand with IP such as Transformers, Peppa Pig and My Little Pony. Hasbro is a classic story of a high quality asset hidden within a poor quality one, with the Wizards of the Coast making up the majority of the company's operating profit with D&D (Dungeons and Dragons) and MtG (Magic the Gathering). These businesses have been growing steadily with high margins and incredibly passionate fanbases. However, Hasbro’s actions surrounding these companies over the past year have shown that not only do they not understand the communities for these games, they completely misunderstand their own businesses and how best to effectively monetise and build their brands. With a track record of abject failure, management are now proceeding are killing their cash cows through penny pinching and over monetising.
D&D
We’ll start off with the biggest controversy currently facing them, the issues around the D&D OGL (Online Game Licence). I believe due to slowing growth in MtG that much of the company’s growth implied in their valuation is expected to come from D&D. In the past I have written about the potential for Hasbro to grow D&D revenues rapidly by consolidating and more effectively monetising what is currently an under monetised business. Management also recognised that D&D was undermonetised and proceeded to take steps to address that. Their solution to this was updating the OGL, a document that dictates the rights of independent 3rd parties to produce D&D licensed products such as monsters, rulebooks and campaigns. The original OGL was loved by the community, who were explicitly told it would never see any changes. Without going into too much detail, the new OGL created a huge amount of red tape and created much stricter licensing rules including the ability for WOTC to terminate that licence at will. It also takes a significant cut of royalties while keeping open the possibility of WOTC changing the OGL however they please further on down the line. Furthermore, creators were given less than a month to make the decision whether or not to go along with it. Thte company has received a huge amount of backlash and has released a second version with some moderate improvements, but there’s a clear element of trust and goodwill that has been clearly lost with the community. Let me explain how that actually impacts the business.
Much of the D&D revenue comes from a core group of superfans, particularly dungeon masters. There’s nothing that forces players to buy D&D products, you can play D&D with a pen and a paper if you want to. Furthermore, there are plenty of other very similar RPG’s one could move to if they wanted. The core D&D customers spend their money due to a combination of convenience and love for the game and company. When I wrote about the company in the past, my suggestions for improving monetisation involved consolidating and offering more premium features for superfans to pay for (eg. map building and miniature creation included in D&D Beyond). This would improve revenue while improving the game experience for those fans, a clear win win. What Hasbro has instead elected to do is squeeze more money from the community while actively restricting them. Furthermore, WOTC has nothing that gives them a strong competitive position here, with nothing stopping this frustrated community from not refusing to buy their products or moving to a new game.
MtG
While D&D is the most prominent controversy at the moment, MtG is their most profitable product and also has some issues developing under the hood. Similarly to D&D, the MtG community is not happy with what’s been seen as pretty blatant money grabbing along with generally poor community engagement. Unlike D&D, MtG hasn’t been under monetised, and in fact has faced the opposite issue. WotC has been accused of overproducing and overcharging for cards, along with rereleasing supposedly limited cards. The collectors economy suffered a crisis last year as many older cards that were out of circulation were re-released as part of a commemorative event. Naturally this caused the value of limited edition cards to crash, upsetting many superfans. This has come along with a ‘new card burnout’ amongst many hardcore superfans who are finding the constant new releases of cards, along with the steadily increasing prices difficult to keep up with. Unlike D&D, WotC didn’t have a lot of goodwill with the community prior, with many issues surrounding the running of their competitive scene. While there isn’t the risk of the fanbase just leaving and finding a replacement like there is with D&D, I believe there to be a significant likelihood of sales underwhelming next year as the fanbase continues to be frustrated around the new card situation. I believe that a majority of the growth currently priced into the stock
Covid Overearning
Finally, Hasbro has arguably been overearning in every segment due to covid. Their consumer products is the most obvious as they saw a big jump in sales along with most consumer products businesses through 2020 and 2021. This has been couple with a big buildup of inventory along with weak sales throughout 2022 for what is already a weak segment of the business. However, there is an argument to be made that both D&D and MtG over earned during Covid as well as people were forced inside to new hobbies. Both products were significant beneficiaries of lockdown and even if player counts don’t fall, it’s hard to see the level of growth continued in the near term especially off such difficult comps.
Valuation
One of the difficulties here is actually putting a valuation on Hasbro. Due to their mess of acquisitions and the lumpiness of their earnings it’s difficult to quantify their normalised earnings power. After adjusting a few things, I believe their normalised earnings power to be around $450m which I got by removing amortisation and estimating Q4 earnings generously. This puts them at a P/E of around 20, which is not cheap, but also not too demanding based on their historical growth. However, I believe based on the case I’ve laid out here that growth will likely slow significantly if not decline in the short to medium term, and their fair value is at most more likely around a 10-15 Pe multiple. Many of these catalysts should be recognised in the next year, which would provide a 1 year IRR of 25-50% if this thesis is correct. Hasbro is fairly uncorrelated to many other short ideas, has cheap borrow and likely limited upside due to its hefty valuation. Due to this, I believe Hasbro would be a good, diversified short for most people’s book.
Edit: After I had finished writing up this pitch, prominent D&D creator DnD Shorts released a video detailing information released to him from various insiders throughout the company.
These leaks basically confirm many of the ideas outlined in my pitch and more, with allegations of a lack of care and awareness of the community from the management combined with a toxic work environment within Wizards of the Coast. Additionally, according to the leaks Hasbro CEO Chris Cocks didn’t even really want the acquisition of D&D Beyond, and the company seem to not have a clear vision for how they want to move forward with the platform. Furthermore, the way that Hasbro has gone after third party products seems to imply a lack of confidence in their own, which make up a significant part of the D&D growth story. If the leaks are to be believed (and there’s no reason not to) then it paints a picture of a management team that is desperate to improve profitability with no regard for the community while completely misunderstanding their relationship and value proposition to their customers. These leaks have given me higher conviction and are pretty harmful to the bull case.