Research: Build-A-Bear-Workshop
Boring Business, increased brand awareness
Description
Build-A-Bear Workshop opened its first store in 1997 and since then the business has grown to reach approx. 359 corporate stores, 92 partner-operated stores, 74 franchised stores plus e-commerce. In around 500 (brick-and-mortar) interactive locations internationally, BBW sells customizable teddy bears and stuffed animals for kids and adults under its own and licensed brands. The business has also a subsidiary which provides entertainment and content to further extend its brand power and customer experience.
BBW market-cap is currently around 416 million with a single digit earnings ratio, generous capital returns and 12,5% free cash flow yield, undervalued on comparative basis. Total revenue in 2023 was 486.1 million, but according to various sources, the global toys TAM is expected to reach 230 billion by 2028 (130 billion in 2020) exhibiting 7.3% CAGR. The product of BBW is of course just a small part of the global market, but it is just to illustrate how much available market there is to reach with increasing brand awareness.
The current CEO, Sharon Price John, 59, has been leading the company since 2013 with around 4% current ownership. John has a broad experience from toy industry, and we believe she is more than capable to lead BBW for further, already proven brand growth. She, for example, spent 7 years at Hasbro overseeing and licensing brands like Nerf, My Little Pony, Star Wars, Marvel and many more. In just a few years after joining BBW, John managed to refresh the company and lead the financial turnaround.
The core business
Build-A-Bear-Workshop is simply selling stuffed animals (and some accessories) which you can design and build in store by yourself or pick from a shelf or online. What does distinguish BBW from a traditional store is that BBW is a combination of entertainment and retail, I would also describe it as an interactive shop. This is what they have to say about competition: ‘’For our retail stores, we view the Build-A-Bear Workshop store experience as a distinctive combination of entertainment and retail with limited direct competition. We are aware of several small companies that operate “make your own” teddy bear and stuffed animal stores or kiosks in retail locations, but we believe none of those companies offer the breadth of assortment nor depth of experience or operate as a national or international retail company.’’ Basically, the statement from 10-k holds true, because there isn’t any direct large competitor with such brand/licensed brand collection, awareness, and size, but don’t mistake for the business to be non-seasonal or non-discretionary product. I would also like to point out that the business has always had a core focus on one single product line, which is stuffed animals, which is why BBW has one of the best know-hows in this single subsegment.
If you’d like to understand the original story of the business or have a store experience view the following videos and read some of the consumer comments:
https://www.youtube.com/watch?v=zO62YLIs9QY https://www.youtube.com/watch?v=mP4WoOUyh7Q
From the picture above, you notice how wide range of licensed brands the business holds to produce current and trendy products. The broad range of external brands I believe is additional strength compared to the competitors. I believe Sharon Price John has fully brought this value to the company, partly thanks to her experience and network from past.
What I was surprised about (as an outsider from Europe) is that BBW alone achieved around 13 billion annual media and PR impressions in 2022 mostly in American sources, up from 10 billion in 2020. What this indicates for me is that the brand awareness is still increasing, but how sustainable is this, I cannot predict.
Almost all the business is operated through DTC, including corporately managed retail stores located in US, Canada, UK, Ireland, and e-commerce sites. That is why most of the analysis should focus on corporately managed stores at least for now. Small portion of the revenue derives from commercial, including third party stores and wholesale product sales. The international franchising is just a fraction, but a great way to increase the brand awareness for potential further international expansion.
Over the years BBW has been able to create diverse formats and to diversify to locations beyond traditional malls, which improved the market positioning significantly. These days you can find BBW from places like cruise ships, six flags, arcade rooms etc. The experience locations even won an award for the business. Additionally, I believe the refreshed model could reduce overall market sensitivity compared to the early years of turnaround. And what comes to the e-commerce, it grew triple digits after lockdowns compared to pre-pandemic (of course like many other businesses during covid), and it was able to capture a lot more teen/adult customers, being 70% from total e-commerce sales. Traditional experience locations still rely mostly on families with kids, where 67% of customers being kids (measured with registered database and consumer surveys).
From the geographical perspective, BBW stores are located around North America, Europe, Asia, Australia and Africa, but most of the revenue is geographically concentrated in US, Canada and UK (8-k, March 2024):
-North America (US, Canada) and Europe (UK, Ireland) with over 350 corporately operated stores, and over 90 third-party retail stores (primarily in US), both combined covering 99% of the revenue.
-International franchising with 74 stores in 8 countries (China, Australia, New Zealand, Qatar, South Africa, UAB, Chile, Kuwait) covering only around 1% of the revenue.
Build-A-Bear-Workshop does not operate any factories and the merchandise is 77% bought from five vendors, who contract manufacturing facilities. By 2022 the supply chain was diversified from being over 90% in China to 58%. BBW owns a 350,000sqf distribution center in Ohio that is serving majority of the stores in US and Canada. They also have a few third-party centers internationally. Distribution is fully handled by third-party logistics providers, and distribution is done regularly with consolidated shipments to reduce costs.
The balance sheet of the business is clean and understandable, without any interest-bearing debt. Around 60% of the liabilities are tied to leases related to retail stores and corporation offices. Most retail store leases have 5–10-year period and can be extended with terms shorter than original lease, providing more optionality. Some of the leases also have early termination options under specific conditions, providing flexibility to relocate stores.
Competition
The closest competitor from a product perspective that I could find is Vermont Teddy Bear, which was listed in NASDAQ until 2005. There is not much available information about their financials, but their peak revenue was expected to be around 40-60 million USD and around 100 employees compared to 486 million revenue and 1000 full-time plus 3200 regular part-time employees for BBW.
Based on an article from 2019, the CEO Bill Shouldice declined to release annual revenues, in which a private equity firm Mustang Group is the owner (link for the article: https://vtdigger.org/2019/09/01/making-it-in-vermont-teddy-bear-company-diversifies-with-unicorns-and-pjs/
Vermont Teddy Bear is mostly an online seller, with only one physical place to visit, the factory. Price range for BBW seems to be larger compared to Vermont, and one of the biggest differences is the lack of licensed trendy brands/animated figures and a huge lack of awareness/presence among the consumers compared to BBW. Based on the available information, Vermont is no threat to BBW, but it could be a potential target of acquisition someday (still quite a small player with little impact for the whole organization of BBW).
The next competitor with similar consumer spending habits and consumption reasons is publicly listed 1-800-Flowers with around 600 million USD market-cap, focused on gifting products like flowers, sweets, snacks, decorations etc. FLWS is not a direct product competitor, but companies like these could be considered as competitors for consumers dollars spent. Like it was said before in the company presentation, it is hard to find a direct comparable competitor with a similar core product and organizational function. BBW adds that they also view competition as any company that competes for family time and entertainment dollars (movie theaters, amusement parks, arcades etc.). Best way to study the investment case is to consider broader spending in this sector and use the comparable companies in valuation purposes.
The multiyear turnaround story beginning 2012
Before jumping into the numbers, we should understand the fundamental change in the company. Between 2009 and 2012 the business was basically in decline both in revenue and profitability, but the company struggled with its structure longer. In 2012 the company revealed a turnaround plan with some of the following key initiatives:
Enhanced experience and new store design
Increased productivity and profitability (closures, relocating, sqf. reduction)
Increased shopping frequency and rebalanced marketing through product, brand, and location
Refreshed loyalty program
Capitalizing brand advertising
Aggressively renegotiating rents
To keep up with the momentum, the company hired the current CEO Sharon John in 2013 and within a few years the company achieved profitability, increased profit margins and overall returns. The results indicate that the BBW brand by itself is strong under the right management. Around 2015-2016 total (bad) stores were down and the additional growth fueling plan was ready (MORE strategy they called it). Management added that the discovery store-format delivered more positive results than heritage-format (by 2023 45% of the stores were turned into new format). John also noticed the importance of location and tourism and added to a plan that they will diversify beyond traditional malls, for example seasonal pop-ups, outlets, shop-in-shops, vending machines etc. The company also began to attract customers of different ages more aggressively by leveraging key licensors, building e-commerce, and developing more teddy-products.
The new strategy could be seen in the overall quality of the business and operational efficiency, but the business was hit again beginning 2016-18 by some external problems like decreased national mall traffic, new privacy law, Brexit, low volume of high impact animated films and so on. 2019 it was again on track to grow revenue and profitability, but unfortunately in 2020 pandemic the business took a big hit in need to temporarily close stores, quarterly revenue almost halved, but on the other hand the e-commerce growth increased triple digits, indicating again, that the brand awareness has increased over the years, and that the customers are still there.
Based on these observations, the turnaround plan has been successful, and the quality of the business has improved year over year, it’s just that it was hidden behind some of the short term external economic problems, which also turned out to be a drag on revenue growth. What I believe is that the company was constantly shaping its turnaround plan and achieved the best of it beginning only in around 2018-2019, which revealed its full potential after the pandemic. And yes, the business is obviously not immune to economical fluctuations, but it’s been more than capable to adopt and to shape its efficiency and support its long-term growth plan.
So far, we have learned the importance to align the business with factors such as location, physical store design and traffic, licensed animation figures and digital transformation (e-commerce). There are clear thesis-supportive signs in 10-k reports where they talk about ongoing lease negotiations, positioning shops closer to seasonal traffic even for short term periods, closing and opening of stores for operational optimizing, increasing international brand awareness through franchises, constantly increasing percentage of new store models, expanding beyond malls, capturing tourism, capturing teen and adult customers and e-commerce etc.
From the graphs above the effect of the turnaround plan led by John between 2013 to 2016 is clearly visible. Between the years 2016 to 2023 BBW was slowly implementing the MORE-strategy including new store format expansion, diversifying locations, operational store efficiency, e-commerce etc. The improvement of business quality was hidden behind formerly mentioned reasons. It took some time to convert the store portfolio into new more profitable format, to place themselves into better locations and to further increase its brand awareness. I highlighted the long-term profitability trajectory with an up-trending arrow. Even in the few declining years of mall traffic and revenue, the EBITDA margin was holding or even growing, again indicating the improved profitability and quality of the overall business. After few a volatile pandemic year, the plan was still intact, and the company returned to the long-term trajectory. Also, gross margins were up from around mid 40’s to mid 50’s and FCF and pretax margins went up sustainably (2020 to present) to around 10-13, after being around 0’s for around 10 years.
I should confirm the comment by management ‘’significant control over its future has been comparatively unrecognized by the market’’ from the presentation of 2023. We should get back to the question of sustainability of growth and profitability later.
Between the transition years, we can notice BBW managed to deliver what they promised in their multi-year turnaround plan (unnoticed organizational changes starting to pay off after 2019 excluding 2020 pandemic lockdown):
-New more efficient store model turning all the stores into profitability in North America, also positively feeding EBITDA margin.
-Stable revenue growth with increased customer acquisition and awareness which in other hand provided higher avg. dollars per transaction.
-By 2023 non-traditional stores 35% of total stores, reaching more tourism, event-driven locations, and higher spending customers.
Running into 2024 and beyond
One might argue that it was pent up demand after the pandemic, but the company has been able to achieve record revenues and profitability YoY for the past 3 years and running into 2024 the long-term plan is still delivering with increased efforts presented in the earnings call of March 2024. In the latest report gross margin was expanding to 54,4 and pretax margin to 13,6, and corporate store margins remaining above 25, indicating that the sustainable profitability and growth has been achieved as was planned in the turnaround plan. Additionally, BBW managed to grow from 409 stores in 2016 to 525 stores in 2024 supported by increased brand awareness, increased store traffic, digitalization efforts and better store positioning. Also important to note that the store traffic has increased versus pre-pandemic traffic decline (outpacing reported national retail traffic 2023).
John highlighted that in the last few years they beat the store opening guidance by over doubling it, and just for 2024 they are guiding at least 50 new locations. The net new unit growth rate has been increasing post-covid, again supporting the long-term growth and demand. What stood out from the call is that they are giving more future weight for partner-operated store models which are supporting further cash flow margin growth (see the graph above) and is great from the capital perspective (wholesale sales to partners). There isn’t any specific guidance about third-party operated stores but are guiding that one to become more accretive part of the business. Third-party stores are providing additional high margin dollars for the company further improving profitability, they claim that it is very asset light for the business to achieve higher cash flow. This discussed part is something to monitor in the future reports, and I believe there is further upside in future FCF.
Second big initiative presented in the earnings call was the ongoing and increased digital transformation effort to further elevate overall efficiency. They created a new role of Chief customer and digital officer to take over CRM, loyalty program and guest service improvements. Shortly explained, they are betting on cohesive digital store and marketing ecosystem to further expand customer base and lifetime value of their customers.
What comes to shareholders, the business has been very generous after achieving sustained profitability and growth. During the year BBW returned 42.4 million through a special dividend and share repurchases and as of March 11, 23,5 million remained available for further share cannibalism. The company also noted that due to favorable market conditions they are going to pay quarterly dividends beginning with 0.20 per share. In the past three years BBW returned over 90 million and bought back over 1 million shares of common (from 16.1 million shares down to 14.8 million), and to be more precise, the return yielded around 30% of its enterprise value. Between the transformation years they are down short 3 million shares, and with sustainable profitability, we expect the share count to decrease further.
The economic structure & comparative valuation
The business has always had a stable cash flow from operations and only two years of negative free cash flow from the past 10 years, and now standing at increased levels thanks to advanced operational efficiency. BBW doesn’t have any debt and didn’t have in the past years. Most of the liabilities are from store leases, short term leases currently at 26 million down from 31 million in 2020 and long-term leases at 57 million down from 120 million in 2020. The economic structure is the reason why the business can achieve high level of ROE and ROIC and I believe it will be much more stable and sustainable going forward after the fundamental change. Equity to Asset ratio is standing at 0.45x (around 0.5 historically) and probably maintain it along increased capital returns to shareholders. No intangibles or goodwill are reported in the balance sheet and for those reasons the tangible book value isn’t the greatest ‘’old school value investor’’ ratio, same applies for competitors with similar economic structure. For me it looks like BBW does not include their brand value in the balance sheet at all after giving a lot of weight on it in the presentations, sounds rational.
Compared to competitors, Mattel has approx. 27% of its total assets in intangibles and around 36% is financed with debt. For 1-800-Flowers intangibles are approx. 23% of total assets and 16% is financed with bank debt.
Based on the fundamental issues discussed and considering the recent developments BBW could probably exchange hands around 7-10x Ebitda or 12-16x P/E in near future, implying approx. 37-53$ share price, not even considering the company’s generous capital returns. I think the successful turnaround deserves a higher multiple.
Based on management guidance of low/mid-single digit revenue growth and approximate financial modelling (on which I don’t usually rely too much) with around rational 10% discount rate, the share price could be around 50 (optimistic).
After reading over 10-year time-line of 10-k’s and presentations, it is absurd to think that in 2019 the stock traded 4.5x street Ebitda. Since then, the stock has appreciated 4x and I believe the intrinsic value is near double for medium-term period. I have been holding this company since June 2023, and I am confident about its long-term future.
Disclaimer
This report is for informational purposes only and should not be construed as investment advice. All expressions of opinion are subject to change without notice and the author has no obligation to update the information contained in the report. The presentation may contain information derived from third-party sources and the author believes that the sources from which information is derived are reliable. However, such information is presented as it is, without warranty of any kind. The reader should note that this information is not investment advice and does not constitute a recommendation to purchase and sell any specific security. As such, the reader should consult with his/her own advisers to determine the analysis.
The author holds long investment position in the company discussed in this presentation. The author stands to benefit if the share price of the stock increase and lose if the share price decline. The author reserves the right to change its views or investment positions at any time, for any reason. The author has no obligation to notify the market about selling or buying the shares of the company discussed in the presentation.
This report contains certain forward-looking statements and projections. These kinds of projections are included for illustrative purposes only. By nature, forward-looking statements involve unknown risks, uncertainties, and other factors. No assurances can be given that the forward-looking statements in this presentation will be realized. The author does not intend to update these forward-looking statements. Use of this report is at your own risk.
Nice write-up on BBW.