FNKO long thesis
While not a dividend stock, FNKO represents another inefficient small cap opportunity that is too great to ignore. Breath-taking growth, an improving balance sheet, and an extremely powerful brand capture the essence of this long-term play. Selling at just 12.5x free cash flow and ~7x Enterprise Value/EBITDA, FNKO is a growth stock priced as value.
Creating pop culture figurines and other licensed pop culture products, Funko has captured the spirit of its fans’ favorite TV shows, movies, and video games for more than a decade. Within the industry, Funko’s fans demonstrate an unparalleled loyalty as a result of Funko’s consistently true encapsulation of their favorite aspects of pop culture. This, combined with a vast and ever-expanding license portfolio defines their strong economic moat, which has driven more than a decade of exceptional growth. While showing slight signs of moderating, impressive double-digit growth still proliferates across the company’s segments and geographic regions. While this still pertains to the relatively mature North America region, true excitement lies in international growth, which recently fell north of 60% year over year. Finally, the long-time elusive flow-through to the bottom line is truly beginning to materialize in a big way. In the most recent year, along with revenue growth, a debt refinancing, afforded by the company’s recent strong performance, really helped to reduce expenses on the interest line. Their resulting increase in cash flow, has begun to allow the company to pay-down their long-term debt. A virtuous financial cycle is unfolding within Funko, providing a cornerstone for our long thesis.
Having said all of that, one must ask himself how FNKO could be such a cheap stock with short interest of 47% of the float as of most recent data. We see three likely, but misguided reasons for this:
- Skeptics believe Funko represents a fad as people have a temporary obsession with their pop culture figurines.
- A large 4 million share insider offering in September near the stock’s all-time high possibly represented an undisclosed internal problem at Funko.
- Because of the above two reasons, FNKO is a great momentum short, stuck in self-perpetuating down trend.
Well aware of the perception of Funko’s products as a fad, we thoroughly examined the company’s brand and its history. As previously pointed-out, Funko has more than a decade of proven success, having sold more than 250 million products. With their in-house design staff and carefully-selected contract manufacturers, Funko demonstrates an incredible adaptability and speed to the market following major pop culture events. Pop culture itself clearly is no fad, demonstrated by society’s continued reverence of near century-old icons. Therefore, it follows that Funko’s figurines and other products will continue to adapt to and represent the undeniable perpetuity of pop culture. Beyond this logical progression, one can see that Funko sells more than just its products — it sells an unforgettable customer experience. While a majority of their sales occur through numerous retail sellers and their online store, Funko’s own stores are the pinnacle of customers’ interaction with the brand. Life-size figurines and incredible decoration in iconic store locations, such as Hollywood, CA, encourage social media photos and generally heighten the desirability of the brand. Viewed in aggregate given large enough sample size, customer reviews do not lie, and Funko’s new Hollywood store earns a near unheard rating of 4.9 out of 5.
Moving on to the issue of certain shareholders of FNKO selling 4 million shares of stock, we see a high level of irrationality to the market’s reaction. The two large shareholders who sold were ACON, the majority owning private equity firm and the CEO, Mariotti. Obviously a prospectus does not state reasons for the filers’ selling, creating a high level of uncertainty for market participants who are taught to beware the informational edge possessed by insiders. However, we constantly remind ourselves that financial markets create great inefficiencies by equating uncertainty to risk. In reality, with FNKO’s IPO only two years past, this sale represented an early post lock-up opportunity for these majority owners to gain some liquidity. Both ACON and Mariotti still have very large ownership after selling a mere fraction of it in this seemingly giant offering. Therefore, while a 4 million shares hitting FNKO’s bid will mark the stock down considerably, the down trend created by follow-through selling represents market participants’ inability to gather facts and differentiate between uncertainty and true financial risk.
Finally, as a direct result of the follow-through selling, FNKO has become a favorite momentum short. A very easy stock to borrow, traders keep selling, pushing it further down on large volumes. Evidenced by an astronomical 47% of the share float short, we see a highly oversold stock. By definition, bottoms are formed at the point of maximum bearish sentiment, and we imagine this is about that point. As the true fundamentals come back to light and the stock starts to put in higher lows, a large short squeeze will likely materialize as the 6 million shares will have to be covered. We are not alone in anticipating this bottom; some of the current consolidation has been determined by a well respected Canadian small cap value fund building a long position equivalent to ~10% of FNKO’s shares outstanding. It is only a matter of time before more of the smart money crowd joins.
Given the facts of the Funko story, and its mispricing, we believe that the risk/reward in this long-term idea is highly favorable. Granted, it is hard to predict the exact timeline for the trade to play-out, and the stock could certainly retest the bottom of its consolidation before moving higher. We plan to be patient with the position as long as the fundamentals remain intact. Also, we would like to specify that FNKO represents an oversized position for us, reflective of the magnitude of opportunity we see here.