I used to be of the view that suggested that buybacks were just another way of distributing to shareholders – a bit like dividends, selectively applied.
You could turn a buyback into a dividend by selling your own shares in precisely the proportion that the company bought shares back. Then your percentage ownership was unchanged and you would have (in cash) your share of the monies that the company distributed to its owners.
I used to think that. But it isn’t quite true. Because companies can impair themselves with buybacks in ways that you just couldn’t with dividends. Few companies support paying dividends at 2x underlying cash generation. But debt funded buybacks of this size are alas fairly common.
Debt funded buybacks, applied to their illogical limit, will corrupt you, and turn you into a gebbeth – inhabited by the debt (and its evils) you have allowed into your body.
First however I need to recount a parable about how leverage corrupts morality.
Valeant and the price of Syprine
Syprine is an old drug, out of patent for years that is a treatment for Wilsons disease. Wilsons disease is a disorder where copper builds up in your blood eventually killing you. If you take Syprine you lead a symptom-free normal life.
There are a few thousand people with Wilsons disease in the United States and as it was a minor disorder there was a single supplier of Syprine.
Valeant bought this single supplier. They cranked the price to $400,000 for a years supply and took every asset of every sufferer they could find.
Pay up or die.
Valeant instituted a patient subsidy program so that they could crank the prices to levels that no patient could afford and then drop the price (through the subsidy) to a level where they could strip every asset of every sufferer. They found precisely how much a Wilson’s disease sufferer had, and they took the lot.
Valeant bought up all the raw-material suppliers for the drug so no alternative supply could make it the market. They either bought up or intimidated all the veterinary suppliers of Syprine so that veterinary supplies couldn’t be diverted. Horses get Wilsons disease too but a few (hundred) dead horses were the collateral damage in Valeant’s plan to extract huge rents from an old-and-out-patent drug.
Eventually this got to a Congressional hearing and Bill Ackman (the activist investor then on the board of directors of Valeant) promised to go to a director meeting and get Valeant to drop their prices on Syprine.
But Valeant didn’t drop its price despite the promises of its (then) largest shareholder, because if they had dropped their prices on Syprine they would not have been able to pay their debt.
Normal people do not tell Congress they will do something and then do the exact opposite. But add in enough debt and decent people will become evil.
That is what happened with Syprine and Valeant.
In the Valeant case the debt came from buying pharmaceutical companies at very high prices. But in the case I am going to show you (Mattel) the leverage can just come from buying back stock.
And the lesson for management teams is if you buy back enough stock at the wrong price you too can become evil.
But let’s start with what went wrong with Mattel.
Mattel, a toy story
Toys are not an easy business. They have a competitor: computer games. Once upon a time if you looked at Mattel it broke down into girls toys and boys toys. Girls toys meant Barbie. Boys toys meant Matchbox (cars) and Hot Wheels.
These were evergreen, growing sales year after year, decade after decade.
Then along came computer games. And boys toys in particular were hit badly. Once upon a time you could sell a Matchbox car to a nine year old. Nowadays the competition is Mario Kart, and frankly Mario Kart is more exciting.
These days the only people who buy Matchbox cars are 3 years olds and creepy 45 year old men.
It is not as if you can’t grow a toy company – but the focus is generally younger and younger. Spin Master grew a large (listed) toy company from nowhere on the success of Hatchimals. A fairly large unlisted toy company was built on the success of Shopkins and other toys aimed at younger children.
With a savvy enough social media strategy you could even make a success of some traditional boys toys. Nerf is an amazing success at least in part based on a craze for making astonishingly violent Nerf War videos and showing them to legions of fans on YouTube.
But that was Hasbro. Mattel was devoid of such success.
And Mattel had some failures too. The most notable one was American Girl an iconic up-market branded doll which Mattel took downmarket (stocking in Toys R Us) and blew up the cachet of the brand.
Once upon a time you could go with your precious daughter to an American Girl shop and have her clothed and her hair cut to match the doll. It was quite the experience. Stocking in mass market shops destroyed this.
What Mattel did have however was buybacks. Lots and lots of buybacks and they kept the earnings per share on a pleasant enough path.
The extraordinary buyback binge undertaken by Mattel is best seen in their cashflow statement. If you want the full version I have prepared Mattel’s accounts for over 20 years, standardised and as presented (courtesy of the wonderful CapitalIQ.com).
Here however is the key summary of the last few years of this binge:
The buybacks (plus ordinary dividends) were way in excess of available cash generated and Mattel accumulated a lot of debt.
The credit rating is now firmly in “junk” territory and is trading (slightly) distressed. The debt trades in the low 90s.
There are now no buybacks now or dividends as cash flow has evaporated.
It is hard to imagine that Mattel, owners of such staples as Barbie, could get itself so knotted, but net debt is now over $2.2 billion. And when there hasn’t been a lick of operating cash flow for two years that becomes difficult.
And even Barbie is a little problematic these days. Comparing Barbie to other dolls on Amazon reveals a lack of pricing power. Indeed it seems the only place with pricing power is the collectables market (and with Barbie that means really creepy forty five year old men).
Why I am short Mattel
I am short Mattel based on seemingly dysfunctional management and too much debt. I regarded these in part as flip sides of the same problem. Too much debt meant that Mattel found it hard to take risks, to invent new toys, to hire and nurture the talent that keeps a toy company fresh.
Debt meant that Mattel had to “milk” brands, prioritising short-term cash for stock repurchase and eventually for interest payments. This led to cashing the iconic American Girl brand in for a short-term sugar hit when it was stocked in Toys R Us.
I knew management were dysfunctional. Churn in the c-suite proves it. But recent stories leave me reeling. Mattel have morphed into a truly evil company. One that kills babies.
The recent big news was that Mattel has recalled the Fisher-Price’s Rock ’n Play sleeper. The story is well told in the New York Times.
Here is the key quote:
When Fisher-Price agreed last week to recall all 4.7 million Rock ’n Plays on the market, it said it was not at fault for the more than 30 infant deaths the Consumer Product Safety Commission had linked to the sleeper.
Instead, the company said the reported deaths stemmed from the sleeper’s being “used contrary to safety warnings and instructions” to buckle babies in with the harness and avoid putting other items in the sleeper. (The safety commission advises that it should not be used once children reach 3 months or show signs of being able to roll over.)
I want you to understand how twisted this is. The company knew babies were dying in this sleeper. But the company wasn’t at fault – it was the parents who used the sleeper in ways that seem obvious if contrary to instructions.
The New York Times demonstrate that the ways people used the sleeper were consistent with Mattel’s advertising/promotions but whatever.
Parents bought this thing and their babies died.
And it wasn’t one death. One death is an accident. At the second death you are probably wondering “is this a product design issue”. At the third death if you are not having serious doubts then you probably lacking basic human morality.
But this was over thirty deaths.
That is thirty families that held funerals for their baby.
I don’t know what you say to parent number 17 whose child died well after it was patently obvious that this thing was killing babies.
One day I guess we will find out what Mattel will say to a jury.
But this is a moral failure truly extraordinary for a company whose key staff have to love children, understand children and design things to make children happy.
Understanding children and designing and marketing things to make children happy
But from what I hear that isn’t what Mattel is about any more. Their management were once from fast moving consumer goods companies (really attuned to milking brands).
Now they are Silicon Valley/social media types (which Hasbro has shown with Nerf might be better), but they seem too focused on selling their existing characters to Hollywood.
But Hatchimals (to pick a success from Spin Master) was a toy aimed at young children designed by someone with flair and a deep empathy with the young children who are the target market.
An empathy and an understanding that seems lacking at Mattel.
The morality of short-selling
I am a short-seller, and sometimes I am betting things fail when I really hope (for society) that they survive.
I am short a very small amount of Tesla and strangely I hope I lose on that bet. Elon Musk has demonstrated that electric cars can be better than internal combustion engines. He has improved the world. I think his finances are a mess and he has other problems. But deep down I hope he succeeds. I feel slightly dirty betting against what is fundamentally a good thing.
And I felt a little dirty betting against Barbie too. After all what is wrong with a toy company?
But there is plenty wrong with this toy company. It kills babies. It fails the basic test of a toy company.
And it will probably go bust too. And it will be deserved. The world will be a better place when the toy company which doesn’t love children and doesn’t design things to make them happy finally fails.
And maybe the next deadly toy won’t stay on the market quite as long. And there will be less grieving parents because this thing has finally filed chapter 11.
I truly hope so.