Is Corgi Due for a Major Revival?

Ever since we made our first big investment score with 4Kids Entertainment (KDE) many years ago, we’ve been on the lookout for other small, undiscovered companies that could profit significantly from hot entertainment properties. We were therefore excited when we stumbled upon Corgi (CRGI), one of the most famous brands in the collectible toy industry.

While Corgi’s business has surely stumbled in recent years due to past management neglect, we think that this solid brand is due for a major revival in the coming year on the heels of a significant business restructuring completed late in 2006. With absolutely no analyst coverage, Corgi’s stock could become a hot commodity once more investors recognize the company’s renewed potential, especially in light of the growing Harry Potter mania.

The Changes: Major Recapitalization and New Acquisitions

Prior to November 2006, Corgi, based in Hong Kong and maintaining offices in Leicester, England and Chicago, Illinois, was one of the oldest marketers of collectible die-cast models of trucks, buses, cars and airplanes in the world. Revenues from this business have been between $75 million and $90 million a year since 2002, and profits for one reason or another have been elusive.

In December 2006, the company completed a major recapitalization, which included extinguishing all debt, a private financing, a reverse stock split, the acquisition of two private companies (one of which is profitable), and a completely new management team. There are enough changes here to make your head spin and the situation clearly demands a closer look. The full details of the recapitalization can be found in a 11/20/2006 filing with the SEC or in this press release.

Recent Acquisitions Add Premium Licenses

The recent acquisitions interest us, because through these purchases, Corgi acquired license rights to some major entertainment properties. Among the exciting properties are: Harry Potter Master Toy License for Europe (note: A new Harry Potter movie is also slated for release in 2007), LucasFilm (Star Wars, note that there is a 30th Anniversary Celebration for Star Wars in 2007), and the much anticipated The Golden Compass Trilogy, also to be released in 2007.

Additional acquired properties include: Pirates of the Caribbean (also slated for a movie in 2007), Narnia, New Line (Lord of the Rings), and Marvel (Classics, Spider Man, Ghost Rider, Fantastic Four, X-Men).

You can see the list of licenses here and here.

New Management Seems Solid

With regard to the other recent changes, it is important to note that Corgi’s new CEO is highly experienced toy executive Michael Cookson. Mr. Cookson’s claim to fame is having been the turnaround CEO for Wham-O, the toy brand for a slew of fun products ranging from Hula Hoops to Hacky Sacks to Boogie Boards. Under his leadership, sales shot from $20 million to $65 million.

Mr. Cookson is now the CEO of Master Replicas, Inc., one of the companies that Corgi acquired in December. Under Mr. Cookson’s leadership, Master Replicas has grown from $0 in revenues to over $45 million in 2005. Master is also profitable with $4 million in net income reported in 2005.

You can read an interesting article about Mr. Cookson here. Mr. Cookson currently holds 1.3 million shares of Corgi stock, which represents about 11.5% of the shares outstanding.

Capital Structure is Clean and Valuation Seems Low

In terms of the current capital structure, our numbers suggest about 12 million shares on a fully diluted basis. The balance sheet also appears clean with the recent financing and the conversion of convertible debt into stock. Finally, according to the recent press release:

For the 12 month period ending March 31, 2008, Corgi expects revenues to range from $110 million to $115 million, which represents more than a 20 percent increase when compared with the combined revenues of the three predecessor companies during the prior year. We target operating margins in the double digit range as a percentage of revenues and net margins after taxes in the high single digit range.

Using the above numbers and the current stock price of $5.00 we arrive at a market value for Corgi of about $60 million, and an EV/Sales of about 0.55. For reference, of the major publicly-traded toy companies, which we currently think are the best comps for Corgi, Hasbro (HAS) trades at an EV/TTM Sales of 1.5 and Mattel (MAT) at an EV/TTM Sales of 2. Both have similar operating margin profiles as Corgi is expected to have. Interestingly, apparently Mattel owned Corgi at one point. Could they be a buyer again if this turnaround materializes? Finally, in terms of an additional valuation point, the recent financing of Corgi in late 2006 of 2.7 million shares for $17.6 million implied a valuation for Corgi of about $6.50 per share.

CRGI 1-yr chart

Risks

On the one hand Corgi faces substantial risks given that it operates in an unpredictable, fickle and faddish industry. The company’s ultimate success will depend upon the success of its entertainment properties. Yet, even if these properties are successful there is no guarantee that they will generate collectible and/or toy sales.

In addition, and perhaps more importantly, the company is fully dependent on licenses from larger companies. These licenses could be revoked at any time. Specifically, as Corgi says in its SEC filing:

Master Replicas’ business has historically relied heavily on sales of its Star Wars products, and if Lucas Films fails to renew its agreement, or the popularity of Star Wars replicas declines, Master Replicas’ revenues could decline substantially. Revenues from the sales of Star Wars products accounted for over 93% of Master Replicas’ revenues in 2005. In light of the popularity of Star Wars among consumers and collectors of replica products, Master Replicas believes that a sales of Star Wars products may continue to account for a significant portion of Master Replicas’ revenues for the foreseeable future. A failure to renew the license agreement with Lucas Films or a reduction in the popularity of the Star Wars replicas, would harm our business.

The Upside Potential

However, even taking the above risks into consideration, we think it is important to note that Corgi’s current properties are hardly “fad” properties. Their customer base is primarily composed of hard-core collectors who are almost fanatical about their devotion to these entertainment properties, such as Star Wars. So this is not your typical faddish toy business. As long as Corgi is able to retain these licenses, and we see no reason why they should not be able to do so, given their proven ability to generate income for the licensors these properties should provide good income and growth for quite some time.

At the same time, the company is projecting about $110 million in sales in the coming year with potential earnings, based on management guidance, of about $1.00 per share. The current valuation of Corgi therefore seems to already discount the above risks, at least as it pertains to the coming twelve months. We also don’t see much risk in buying at a valuation that is lower than that given to the company by insiders in the recent financing.

On the upside, we suspect that the company’s estimates for the next year are very doable. Interestingly, out of the top 10 movies predicted in 2007, Corgi now has licenses for half of them, including the new Harry Potter movie. If any one of the handful of Corgi’s properties hits big, the sales numbers could easily be revised sharply upwards.

All in all, with recent financial guidance implying minimal downside risk over the next year, and new product launches potentially leading to substantial upside, we think that Corgi looks like a solid investment gamble at current prices.

For additional research, we suggest you listen to Corgi’s analyst presentation, given by the CEO on February 20th.

Disclosure: Affliates of Envoy Global Research hold shares in CRGI. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.