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In March 2007, Michael Eisner, with the help of Madison Dearborn Partners, made a $9.75 per share all cash offer for Topps, Inc. (TOPP). Recently, the Upper Deck, LLC the sole rival to Topps in the trading card business submitted a $10.75 all cash offer.

In our eyes, the Topps buyout discussion is signaling a top (no pun intended), in the Private Equity industry. Any investor who understands the landscape of the trading card market of the past 15 years knows that such a buyout makes no sense. In essence, the deal makes perfect sense for Upper Deck, but not for Private Equity. Any Private Equity firm interested in Topps has money burning a whole in the company’s pocket.

First, why would anyone want to buy a company like Topps, Inc.? The company has nearly $81M in cash, or about $2.10 per share, and a $5.24 book value. These facts make Topps an attractive buyout candidate because there is no debt on the balance sheet.

In essence, owners of Topps shares are getting $2.10 in cash, $3.14 in tangible assets, and finally paying $5.18 per share for the business. On the look of it, a price range of $9.75 to $10.75 per share looks cheap. The problem is that anyone with an understanding of the trading card business should be baffled by Eisners offer, quizzical of Upper Deck’s offer, and understanding of Topps anti-trust concerns.

To understand our discontent with the coverage and analysis of this situation, investors must start with a simple history of the trading card market over the last 26 years. In 1981, Topps lost its monopoly on baseball cards when Donruss and Fleer, were allowed licenses to produce baseball cards. These companies were the big three until the late 80s when Score, Sportflics, and Upper Deck came alive.

Upper Deck’s product would revolutionize the industry, which helped send trading cards on a downward spiral beginning in 1991. With the advent of premium brands such as Studio, Leaf, and Topps Stadium Club, trading card producers started to price themselves out of the market. Children paying $0.50 for a pack of 15 cards and stick of gum, were no longer the target market. Rather, the companies sought to reach more adults with prices of nearly $3.00 for a pack of 15 cards, and no gum.

This premium mania caused numerous bankruptcies, mass consolidation, and inflated prices. During the 1990’s, companies like SkyBox, Hoops, Score’s multiple sub-brands, Pacific, Playoff, Classic, Collector’s Edge, GameDay, and even Ted Williams attempted to obtain a market share. The result was an extreme saturation of the market, with each company producing nearly 10 different brands a year on average by 1999.

Beckett Publications, the main price guide for trading cards, had to substantially condense its pricing coverage in order to provide pertinent pricing data. By the early 2000’s, the market was so saturated that Beckett had to begin producing a monthly guide, and a quarterly guide, in order to provide adequate pricing for all of the products on the market.

Ultimately, the mass market saturation resulted in numerous bankruptcies. Many of the smaller brands listed above, would be gone before 2002. These included, Ted Williams, GameDay, Hoops, and SkyBox which became part of Fleer. Playoff would be bought, along with Score and Donruss. Pacific would become extinct due to a lack of licenses from the MLBPA, and NFLPA, that were needed in order to produce cards.

The consolidation would leave Fleer, Topps and Upper Deck as the big three. As these companies competed, the target market became even more luxurious, as the companies began to offer packs of cards at $100 for 4 cards. This attraction to the high luxury market led to the fiscal insolvency of Fleer, which apparently is now part of Upper Deck.

History now brings us to the current paradox which is found in the following questions, and their answers:

Why would Mr. Eisner want to buy Topps?

Mr. Eisner, and Madison Dearborn Partners are interested for the cash position, and the ability to purchase a cheap business. The beauty of the transaction is that Mr. Eisner would be getting a premium brand for a discount of about $81M. This means that rather than paying $377.9M for the company, he really only pays $296.3M. The cash position acts as a discount since no debt exists.

Mr. Eisner and Madison Dearborn like this position because Topps has $326.7M in revenue, and they would be paying only $296.3M for this revenue stream. At first glance, it's not a bad deal, especially if these private equity investors are able to turn the business around. The problem is that, given the climate of the industry as a whole, we do not believe the problems that face Topps, Inc. can be turned around by intelligent financiers.

The major problem facing the trading card industry is that per pack prices have seen Weimar Germany-like inflation over the last 15 years. In 1990, a collector could purchase a pack of 15 premium cards for about $2.00. Today, that same pack averages $3.00 for 3 or 4 premium cards. The price per card in 1990 was about $0.13, and today that same card costs collectors $1.00. This results in about 669% inflation for the 15 year period.

Does Upper Deck really think that the FTC would allow them to buy Topps?

Upper Deck is probably interested for the same financial reasons as Mr. Eisner, however. Upper Deck has more enticements to complete the transaction. The company’s product is superior to Topps, adding the Topps brand to Upper Deck would give it a monopoly and prestige among collectors that has not existed since 1981; in essence there would be a trading card monopoly with Upper Deck being the winner.

The problem is that Upper Deck made an inferior offer if they want to be taken seriously. To understand why, investors need to analyze the goodwill that the Topps brand would bring to Upper Deck. Trading card collectors would probably agree that the value of the Topps brand is worth more than the $1 premium over Mr. Eisner’s offer.

As stated earlier, if the Upper Deck purchase were to be completed, a monopoly in trading cards would exist. This is highly unlikely, since the FTC would most likely halt the transaction. That being said, it would seem justified that Upper Deck would offer a higher bid if it truly wanted to secure the Topps brand. The $10.75 per share price is truly inferior to the $9.75 price due to the unlikelihood of completion.

Why do analysts think Topps is wrong to suggest anti-trust problems regarding Upper Deck’s offer?

Topps is warranted in its concerns that the Upper Deck bid would not be consummated due to FTC concerns. If Upper Deck bought Topps a monopoly would exist, and the FTC exists so such scenarios do not unfold. This reason alone makes Mr. Eisner’s bid superior even though his offer is $1.00 less than Upper Deck. We believe that Upper Deck does not adequately compensate investors for the amount of risk that exists regarding its offer for Topps.

Here are some articles so that our readers may see what other people are saying about Topps:

  • Clyde Milton's Take On Mr. Eisner's Offer for Topps
  • Gannon On the Topps Take Out Offer
  • Rick Munarriz's, The Motley Fool, Take On the Bidding War
  • We do not recommend investors purchase shares in Topps, Inc. Investors would be better off going to www.ebay.com, and purchasing as many 1986 Topps Traded sets as possible for whatever amount one would invest directly in Topps, Inc. Investors are better compensated for the risk inherent in the latter investment.

    TOPP 1-yr chart:
    TOPP 1-yr chart

    Disclosure: The author does not own any shares in Topps, Inc. and will never purchase any.

    Source: The Height of Private Equity: Topps, Inc.