Will the success of the 'blind boxes' continue?
This article is part II of our analysis on Pop Mart (PM) – check out part I before you read.
We expect PM to preserve its economy of scale in the near future because of its ability to commercialize IP designs and distribute them.
However, a long-term concern in the upstream is PM's ability to source and commercialize the right IPs. Although we have seen PM successfully expand its IP portfolio to 85 total IPs, with 34 being either proprietary or exclusively licensed to PM, the top two IPs, 'Molly' and 'PUCKY', took 45% of sales in 2019. This high dependence on a few IPs might expose PM to higher risks if the core IPs are no longer attracting consumers.
While the upstream advantage is expected to remain stable, PM's downstream operation might be short of a hyper-growth story.
PM's downstream sales network includes 114 retail stores in 33 cities in China, 825 roboshops in 57 cities, online stores, pop toy conventions including BTS and STS, and wholesales channels in China and overseas. Over the past three years, the most dominant channels are retail, online and roboshops. Among them, online channels have seen the most significant growth as a percentage of total revenue, from 9% to 32%. Retail sales also saw strong growth, with a 25% growth in 2018 and 65% in 2019.
Yet-to-be-proven sustainability
Despite a staggering bottom-line growth in 2018 and 2019, the sustainability of this growth has become the main concern.
We examined the historical drivers of the impressive sales from both upstream and downstream perspectives.
While retail and online channels have seen significant growth, a few things do not add up in PM's current growth story: 1. as retail stores and roboshops now cover most tier-1 and tier-2 cities, the management has noted that expansions to lower-tier cities are not considered for the near future; 2. the average year-over-year revenue growth per roboshop for 2019 declined to -9% from 157% in 2018.
In terms of retail store sales, total revenue grew 198% in 2019, over a year ago, while doubling the number of stores to 114 from 63. It has no near future plan of expansion to lower-tier cities according to company cofounder Si De (in Chinese). PM is likely to lose the upside from China's massive and lucrative 'sinking market.'
We also need to consider the stability of growth in single retail store sales.
In the recent two years, PM revamped many stores to create tailored environments and added features such as cafés to attract more customers. However, the growth rate for single store sales might become stagnant, which can be attributed to two factors: 1. given the wide store coverage and penetration in tier-one and tier-two cities, there might be limited added consumers in the future 2. there is a high risk of customer churn due to making purchasing toys into a high-frequency habit for folks being tricky. The drastic drop in roboshop sales from 2018 to 2019 indicated an attrition in the heat of existing IPs, and this has brought us to the question of the durability of each IP in PM.
Unlike retail stores, that can attract customers with added features and in-store experience, or expanding online channels that are reaching to more consumers, the roboshop is almost purely dependent on the demand for the IPs in the machine. So, the recent decline in roboshop growth rates could be a sign of reaching the plateau of consumer demand in the current IPs, or a shift in attitude towards the thrill of opening mystery boxes. In our view, the plateau in roboshop sales growth has a more serious implication than the 15% of PM's revenue it currently takes. It reveals the risk of high dependencies in PM on a few IPs going into the future.
Pop Mart failed to build a large and active fan community group, possibly due to the firm's lack of genes for online traffic-purchase conversion.
Heytea, a representative of new-generation consumer brands, has 22 million registered users of its WeChat mini program, all of whom can easily use it to order drinks. Thus, it can take full advantage of the online traffic pool, analyze customer purchase preferences, and market the products efficiently. Contrary to Heytea, PM has only millions of digital registered users, which might be harmful when closing the loop of supply and demand.
Valuation
We estimate Pop Mart's valuation at CNY 34 billion (USD 4.9 billion), based on a DCF methodology. The revenue growth forecasts for 2020/21/2022 are 100%/80%/60% reflecting Pop Mart's market leadership in the burgeoning pop toy market, and the ecosystem it is building to acquire new IPs. We note that Pop Mart's projected margin profile is relatively thin for 2023 and 2024, to reflect: 1. the high risks of retaining users with highly concentrated IPs; 2. no strong in-house IPs; 3. A weakness in building closed-loop transaction ecosystem, high risk of new product innovations. We remain bearish on the long-term growth potential and user stickiness. We apply a 13% WACC and a 1% perpetual growth rate. Our bull case and bear case scenario valuations suggest a 26% upside and 27% downside, respectively.