Funko Q3 23’ Investment Thesis Update

Executive Summary

Thesis I: Funko is Making Strategic Adjustments to Regain Momentum

Expansion and Operational Challenges: Over-extension into new product lines leading to complexity and focus dilution.
Strategic Refocusing: Streamlining product lines and SKUs by over 30%, adopting a data-driven approach.
Innovation and Creativity: Maintaining a commitment to core values while aligning with market demands.
Return to Entrepreneurial Roots: Embracing agility, lean operations, and ROI-driven strategy.
Lean Startup Mentality: Focusing on high-quality, limited products and disciplined resource allocation.
Inventory Management: Adjusting strategies in response to wholesale customer trends and market adaptation.

Thesis II: Direct Sales Channel Represents a Significant Opportunity to Diversify Revenues

Omnichannel Strategy Success: Strong e-commerce growth and effective physical store performance.
Leveraging Pop Culture Events: Utilizing events like Comic-Con to boost e-commerce revenue and customer engagement.
Building a Brand Community: Focusing on nurturing a loyal community that connects deeply with the brand.

Thesis III: Massive and Expanding Collectibles TAM

Collectible Toy Industry Ecosystem: Diverse participants, product range, and multifaceted benefits.
Role of Licensed Properties and Pop Culture: Driving economic activity and cultural significance.
Growth of Collectible Toy Industry: Market value and projections indicating exceptional growth.
Broader Toy and Games Market Growth: Linked trends in the global market and potential growth drivers.
Box Office Spending Impact: Influence on collectible toys and potential industry strikes impact.

Funko's strategic recalibration, focusing on its core business strengths and embracing direct sales, positions it well to harness the opportunities in the expansive collectibles market. While past operational challenges have overshadowed Funko's intrinsic brand value, the recent shifts signal a return to its foundational elements of innovation, creativity, and market responsiveness. This realignment, coupled with the growing demand in the collectibles segment, underscores Funko's potential for resurgence and growth in the market, offering a promising outlook for the company.

Thesis I: Funko is Making Strategic Adjustments to Regain Momentum

Thesis Summary

1. Expansion and Operational Challenges

Initial Expansion: Funko broadened its product range beyond core Pop! figures, aiming to capture new markets.
Operational Impact: This diversification led to increased complexity and a dilution of focus, affecting operational effectiveness.

2. Strategic Refocusing and Streamlining

Product Line Reduction: Funko cut product lines and SKUs by over 30% to regain focus and operational efficiency.
Data-Driven Strategy: The decision to streamline was guided by a data-driven approach, emphasizing the importance of analytical decision-making.
Operational Model Change: Workforce reductions and a leaner operational model aim to make Funko more agile in the competitive collectibles market.

3. Innovation and Creativity Focus

Commitment to Core Values: Despite narrowing product lines, Funko continues to prioritize innovation and creativity.
Market Responsiveness: The focus on key initiatives, driven by data and strategic planning, aims to refine product offerings to align with market demands.

4. Return to Entrepreneurial Roots

Agility and Flexibility: Funko is revisiting its identity as a "fast-moving entrepreneurial disruptor," emphasizing the need for agility and streamlined processes.
ROI-Driven Strategy: There's a shift towards a more stringent, ROI-focused investment and spending strategy, essential in a market with rapidly changing consumer tastes.

5. Lean Startup Mentality and Effective Resource Allocation

Streamlined Product Assortment: Funko is adopting a lean startup approach, focusing on a limited number of high-quality products.
Disciplined Resource Allocation: Investments are focused on projects that are crucial to the core business and financially viable.

6. Inventory Management and Market Adaptation

Wholesale Customer Trends: Retailers reducing stock led to a temporary decrease in Funko’s sales, reflecting wider market trends post-pandemic.
Inventory Strategy Adjustment: Funko is reducing new product orders and managing inventory to balance product availability with the risk of overstocking.

7. Diverse Retail Strategies

Contrasting Approaches: Funko’s inventory strategies differ between its wholesale partners and its own retail outlets, highlighting diverse challenges within the retail sector.

Strategic Shift in Funko's Business Model

Funko's recent strategic shift and business model adjustment provide key insights into product management, market responsiveness, and operational efficiency. Initially, Funko expanded beyond their core Pop! figures into a wider range of products and formats. This expansion was theoretically a smart move aimed at capturing new market segments and diversifying revenue sources. However, this strategy inadvertently led to increased complexity and a dilution of focus, subsequently affecting their operational effectiveness.

This loss of focus on core competencies, such as rapid market response, nimbleness, and creativity, underlines the vital importance of maintaining agility in the ever-changing pop culture merchandise sector. Funko's rapid introduction of numerous product lines and stock-keeping units (SKUs) led to overextension. Not all these new additions were contributing effectively to revenue growth or profitability, exemplifying the dangers of over-diversification: resource dilution and potential alienation of core customer groups.

Operational Efficiency and Product Line Streamlining

Funko's decision to cut their product lines and SKUs by over 30% marks a strategic endeavor to regain this lost focus and operational efficiency. This streamlining effort is in line with the demand for operational excellence and the ability to adapt swiftly to market shifts. By focusing on a simplified product range, Funko aims to concentrate on fewer, more lucrative lines, ensuring that each product is meaningful and value-adding. This refined approach is anticipated to enhance inventory management, decrease costs, and enable quicker response to market trends and consumer needs.

Data-Driven Strategy and Workforce Adjustments

Additionally, Funko's use of a data-driven strategy to determine which products to keep or discontinue highlights the significance of informed, analytical decision-making in a data-rich business landscape. This strategy indicates a shift towards a more analytical understanding of market dynamics, customer preferences, and the financial impact of individual products.

The workforce reductions stemming from this strategic refocusing, although difficult, signal a move towards a more streamlined operational model. This leaner approach is likely to make Funko more resilient and agile in the highly competitive and rapidly evolving collectibles and pop culture merchandise market.

Despite narrowing their focus on product lines, Funko's commitment to innovation ensures that creativity and originality continue to be at the heart of their brand. The focus on key initiatives driven by solid data and strategic planning aims to refine their product offerings. This approach ensures that each new product not only aligns with market demands but also significantly contributes to Funko's overall growth.

Funko's reorientation towards its original identity as a "fast-moving entrepreneurial disruptor" marks a significant change in their approach to business strategy and operations. This pivot emphasizes the need for agility, streamlined processes, and a focus on cost-effectiveness and profitability in the dynamic, competitive realm of collectibles and pop culture merchandise.

Recommitment to Core Values and Agile Business Practices

By revisiting its roots as an entrepreneurial innovator, Funko demonstrates a recommitment to creativity, rapid action, and flexibility. This move implies a conscious shift away from past strategies that may have caused overexpansion or a dilution of their fundamental strengths. Prioritizing quick and adaptive responses to evolving market conditions and consumer preferences, Funko aims to preserve its competitive edge in the industry.

Emphasizing the requirement for every dollar spent to yield results reflects a shift towards a more stringent, ROI-driven investment and spending strategy. In a market characterized by swiftly changing consumer tastes, such disciplined and strategic resource allocation is essential. This approach ensures that investments are focused and impactful, contributing directly to the company's growth and profitability.

Strategic Resource Allocation and Fan-Centric Philosophy

Their fan-centric philosophy underscores a dedication to deeply understanding and serving their primary audience — the enthusiastic collectors and pop culture fans. This strategy involves not just creating appealing products but also nurturing a community and fostering loyalty, which are crucial for enduring success.

Funko's adaptation of a lean startup mentality, eschewing complexity, and focusing on a limited number of excellently executed products is a strategic response to past issues of over-extending their product line. Recognizing the value of a more concentrated, high-quality product assortment aligns with a philosophy of streamlined operations and market relevancy. This approach promotes operational efficiency and ensures that every product is a deliberate fit for their brand and business aspirations.

Investing in areas that are manageable, quantifiable, and profitable underlines a commitment to a data-driven and result-focused strategy. This disciplined resource allocation guarantees that efforts are concentrated on projects that are not only integral to the core business but also provide tangible contributions to the financial bottom line, ensuring each venture is both a strategic and profitable endeavor.

Finally, the concept of "keeping the flywheel turning" suggests a strategy of maintaining a self-reinforcing cycle of activities that foster ongoing growth and development. For Funko, this could involve constant fan engagement, continuous innovation in their product lines, and effective marketing strategies, all working synergistically to drive and sustain business expansion.

Market Adaptation and Inventory Management Insights

Funko's performance in the second quarter, coupled with strategic adjustments, offers significant insights into inventory management, market adaptation, and demand forecasting in the evolving post-pandemic retail landscape. The company's experience with major wholesale customers reducing their stock, resulting in a temporary decrease in sales and a revised outlook for the full year, underscores the impact of market shifts and evolving retail strategies on suppliers like Funko.

This reduction in inventory by wholesale customers is indicative of a wider market trend. Retailers, possibly having overestimated stock needs due to heightened demand during and after the pandemic, are now recalibrating their inventory levels to align with the current market environment. This realignment has led to a temporary dip in Funko's sales. However, Funko's expectation of a return to normal buying patterns after this period of inventory correction suggests they view this as a short-term hurdle rather than an indication of a long-term drop in demand.

Funko's report of starting to receive larger replenishment orders, coupled with their cautiously optimistic stance—though not yet identifying it as a definitive trend—points to potential market stabilization. This optimism, supported by recent POS data and improved sell-through rates, hints at enduring demand. Nonetheless, the careful attitude in forecasting and managing inventory reflects a more structured and data-informed approach, shaped by previous experiences.

In adjusting their inventory strategy for the second half of the year, Funko is navigating a fine line between ensuring product availability and avoiding the excesses of overstocking. By consciously reducing new product orders and accepting the risk of missed sales opportunities to avert surplus inventory, Funko is showcasing a more circumspect inventory approach. This method emphasizes the need for flexibility and a rapid response to market conditions over the conventional target of always meeting maximum possible demand.

Furthermore, the contrasting inventory strategies between Funko's wholesale retail partners and their own stores highlight the varying challenges within the retail sector. While Funko's wholesale partners are scaling back their inventories, likely to keep financial and operational agility, Funko’s retail outlets may not be under the same constraints. This difference allows for a more varied approach to inventory management across different sales channels, reflecting the diverse strategies needed in today's retail landscape.

Thesis II: Direct Sales Channel Represents a Significant Opportunity to Diversify Revenues

Thesis Summary

1. Omnichannel Strategy Success

E-commerce Growth: Funko experienced a significant 19% year-over-year increase in e-commerce sales, indicating a strong digital presence and adaptability to changing consumer behaviors.
Physical Store Performance: Despite the general downturn in physical retail, Funko's stores saw a 10% increase in year-over-year sales, highlighting the unique appeal of their physical shopping experience.

2. Leveraging Pop Culture Events

San Diego Comic-Con Impact: Funko's new product launches during the San Diego Comic-Con resulted in a remarkable 50% surge in e-commerce revenue.
Engagement and Experience: These events are used not just for sales but also to create engaging experiences that resonate with Funko's dedicated customer base, fostering brand loyalty and advocacy.

3. Building a Thriving Brand Community

Beyond Immediate Sales: Funko’s strategy extends beyond just selling products; it involves nurturing a community that feels a strong connection to the brand.
Customer Engagement and Loyalty: Events like San Diego Comic-Con and Funko Fund Days demonstrate Funko's success in building a loyal brand community, which is crucial for direct sales and word-of-mouth marketing.

In Q2 23, Funko's digital strategy stood out amidst general retail softness, providing critical insights into their strategic approach and understanding of consumer dynamics. Their growth in sales across both e-commerce platforms and physical stores, albeit the latter constituting a smaller revenue share, underscores their successful omnichannel strategy. This is particularly evident in the impressive 19% year-over-year increase in e-commerce sales, showcasing Funko's strong digital foothold and their agility in adapting to evolving shopping habits.

A notable example of this success can be seen during the San Diego Comic-Con, where Funko launched new products leading to a staggering 50% surge in e-commerce revenue. This outcome isn't just about profits; it illustrates how Funko effectively uses pop culture events as significant engagement avenues. At such events, Funko doesn't only sell products; they create a compelling experience that resonates deeply with a passionate and dedicated customer base. This strategy goes beyond immediate sales, helping in nurturing brand advocates and ensuring repeat patronage.

The 10% increase in year-over-year sales in physical stores further demonstrates Funko's unique market position. In an era where many physical retail sectors, especially in non-essential goods, are experiencing a downturn, Funko's ability to defy this trend is remarkable. It suggests that their stores and products offer more than just goods; they provide memorable experiences, a crucial differentiator in the current retail landscape.

The enthusiastic customer responses seen at events like San Diego Comic-Con and Funko Fund Days are testimonies to Funko's thriving brand community. Such a community isn't merely an audience; it's a strategic asset in today's marketplace, fostering a sense of belonging among consumers. This not only supports direct sales but also amplifies word-of-mouth marketing, a vital component for long-term business sustainability.

Thesis III: Massive and Expanding Collectibles TAM

Thesis Summary

1. Collectible Toy Industry Ecosystem

Participants: The ecosystem includes manufacturers of collectibles, individual artisans, and a diverse range of buyers including collectors, investors, hobbyists, and casual shoppers.
Product Diversity: Products range from vintage toys to modern, technologically advanced action figures, with limited edition and artist-signed pieces holding high value.
Beyond Ownership: Collectibles serve various purposes beyond ownership, such as completing collections, storytelling, and social interaction, and have multifaceted benefits including economic gain, emotional value, and community belonging.

2. Role of Licensed Properties and Pop Culture

Catalyst for Economic Activity: Licensed properties from movies, TV series, and other media are crucial for creating merchandise that resonates with audiences.
Cultural Significance: These collectibles act as tangible representations of fandoms and are significant sentimental artifacts of pop culture.
Generational Appeal: Pop culture phenomena cross generational divides, sustaining the vibrancy of the collectible toy market.

3. Growth of the Collectible Toy Industry

Market Value and Projections: The global Toy Collectibles market, valued at $18.20 billion in 2022, is expected to reach $36.13 billion by 2029.
Exceptional Growth: This segment's growth, driven by emotional connections and cultural impact, is outpacing the general toys market.

4. Broader Toy and Games Market Growth

Global Market Trends: The global toys market is expected to grow significantly, fueled by consumer electronics, AI, IoT, and machine learning technologies.
Symbiotic Relationship: The collectible toy market's growth is linked to the broader toy market through shared drivers like popular culture and consumer spending power.

5. Box Office Spending and Impact on Collectible Toys

Strong Box Office Performance: Significant increases in box office spending, driven by major franchise films, indicate strong consumer interest in related collectibles.
Potential Industry Strikes Impact: Strikes in the cinema industry may disrupt movie releases and merchandising but also build anticipation for future releases, potentially benefiting collectible toy sales.

Ecosystem of the Collectible Toy Industry

In the ecosystem of the collectible toy industry, the marketplace serves as a bustling hub of transactional activity, catalyzing a cascade of economic and social interactions that extend far beyond the initial point of sale.

At the core of this ecosystem are the sellers and buyers. Sellers include an array of entities from large-scale manufacturers known for producing highly sought-after series of collectibles, to individual artisans specializing in niche, handcrafted items. These sellers operate through various channels, with online marketplaces and specialty stores being particularly prominent. Buyers, on the other hand, are a diverse group comprising dedicated collectors hunting for the missing pieces of their collections, speculative investors looking for toys with appreciable value, hobbyists who derive joy from the lore and community engagement, and casual shoppers purchasing for pleasure or gifting purposes.

The products that animate this marketplace are just as diverse as the participants. They range from vintage toys that evoke a sense of nostalgia to modern action figures equipped with the latest technological embellishments. Limited edition models and unique, artist-signed pieces are particularly valuable within this ecosystem, often serving as the crown jewels of personal collections.

When these products leave the marketplace, they carry with them an activity-based utility that transcends simple ownership. For collectors, the toys may complete a set that represents years of dedication, thus providing immense personal satisfaction and a sense of identity within collector communities. Hobbyists might integrate new purchases into games and narratives, using them as tools for storytelling and social interaction. Creative individuals might engage with their collectibles in a different manner, customizing or repurposing them in ways that imbue them with new life and meaning.

The benefits reaped by the buyers are multifaceted. For the collectors and investors, there's the potential economic gain as items appreciate in value over time. Yet, for many, the true value lies in the psychological and emotional realms—pride, nostalgia, joy, and a sense of belonging to a community of like-minded individuals. The collectibles become more than mere objects; they are symbols of personal milestones, achievements, and memories. They can inspire creativity, foster connections, and even serve as a form of cultural currency within certain social circles.

Role of Licensed Properties in the Collectible Toy Market

Licensed properties play a pivotal role in the collectible toy industry's ecosystem, acting as a powerful catalyst for both economic activity and cultural engagement. These properties—ranging from blockbuster movie franchises, popular television series, iconic comic book heroes, to video games and even musicians—provide a rich source of content that toy manufacturers can tap into to create merchandise that resonates with a broad audience. Licensing agreements allow manufacturers to produce toys and collectibles that carry the weight of established fandoms, thereby reducing the risk associated with bringing new products to market.

In this ecosystem, licensed collectibles often become highly coveted items due to their connection with beloved characters and worlds. They serve as tangible representations of the fan's passion for the media, often acting as artifacts of pop culture that hold significant sentimental value. The success of these collectibles is heavily influenced by the popularity and longevity of the licensed properties they represent; a movie that captures the public's imagination can lead to a surge in demand for related toys.

Pop culture serves as the lifeblood of this ecosystem by continuously generating new content that fuels consumer interest and collector enthusiasm. It helps to create and sustain the narratives that make collectibles more than mere toys—they become part of a larger story that the collector is invested in. The characters and stories that permeate popular culture become immortalized through these toys, and in doing so, they carry forward the legacy of the media they represent.

Moreover, pop culture phenomena have the power to cross generational divides, creating opportunities for engagement among diverse groups. For instance, collectible toys from a classic film series can appeal to those who experienced the media in its original release, as well as to new fans who discover it through contemporary reboots or remakes. This cross-generational appeal helps sustain the vibrancy of the collectible toy market.

In essence, licensed properties and pop culture are integral to the collectible toy industry, providing a steady stream of content that fuels consumer interest and drives the creation of products that are cherished not only for their material but also for their cultural value. They are the engines of narrative and identity that make collectible toys a unique and enduring part of the global marketplace.

Growth and Dynamics of the Collectible Toy Market

The collectible toy industry stands as a particularly vibrant subset of the broader toy market, marked by exceptional growth and a fiercely devoted consumer base. In 2022, the global Toy Collectibles market was valued at $18.20 billion, and it is projected to more than double, reaching $36.13 billion by 2029, with a remarkable CAGR of 10.82% during the forecast period of 2023-2029. This segment benefits from the deep emotional connections that consumers have with collectibles, often driven by nostalgia, the cultural impact of various media franchises, and the perceived investment value of rare and limited-edition items.

When contextualized within the entire toys and games market, the collectible toy industry's growth is not only exceptional but also illustrative of broader trends. The United States toys and games market is expected to grow at a 3.75% CAGR from 2023 to 2028, with revenues projected to increase from $38.51 billion to a larger figure by the end of this period. The global toys market—encompassing all types of toys, including collectibles—is expected to grow from a valuation of $108.29 billion in 2023 to $156.96 billion by 2032, at a CAGR of 4.1%. This sustained growth across the board is reflective of the robust health of the toy industry and the successful integration of traditional physical toys with emerging digital trends and consumer preferences.

The collectible toy market's growth is outpacing the general toys market, suggesting that while general toy consumption continues to expand, there is a particularly strong surge in the demand for collectibles. This surge can be linked to the broader toy market through the shared drivers of growth such as the influence of popular culture, the global reach of entertainment franchises, and increasing consumer spending power. Licensed properties from movies, television shows, and comics play a crucial role in this relationship, serving as a bridge between the collectible toy industry and the larger toy market by creating a continuous demand for themed toys that appeal to both broad and niche audiences.

Moreover, projections from the IMARC Group and Grandview Research indicate that the global toys market size was $170.7 billion in 2022 and could increase to $267.9 billion by 2028, and $308.21 billion by 2030, respectively. These optimistic forecasts are a testament to the industry's adaptability and innovation, with the collectible segment being a key driver of this positive outlook.

Overall, the collectible toy industry, though a specific niche within the larger toys and games market, is a significant contributor to the overall growth of the sector. Its remarkable expansion is indicative of larger patterns in consumer behavior and the evolving landscape of play and collection. The link between the collectibles and general toy markets is clear: as pop culture continues to flourish and consumer spending on toys remains strong, both sectors benefit and propel each other forward in a symbiotic relationship that underscores the cultural and economic relevance of toys in society.

Impact of Box Office Performance on Collectible Toy Industry

The data on box office spending in 2023 provides valuable insights into the potential trajectory of the collectible toy industry, particularly the segment dealing with licensed properties. With a significant 28% increase in box office spend in Q1, led by major franchise films such as "Avatar," "Ant-Man and the Wasp," "Creed III," and "Puss in Boots," there is a clear indication of strong consumer interest and engagement with these properties. The success of these films often translates into heightened demand for related collectibles, as fans look to purchase merchandise that allows them to connect more deeply with their favorite characters and stories.

The trend continues into Q2 with a 15% increase, driven by blockbuster titles like "Super Mario," "Guardians of the Galaxy," "Spider-Man," "The Little Mermaid," and "Fast X." These franchises, with their established fan bases and cultural impact, are typically associated with a wide range of toys and collectible items. The impressive box office figures suggest that consumer appetite for these franchises remains strong, which bodes well for the sales of associated collectibles. The success of "Super Mario," for example, indicates a significant opportunity for growth in collectibles related to gaming and animation, given the character's long-standing popularity and cross-generational appeal.

The strikes within the cinema industry pose a challenge, potentially disrupting the regular flow of movie releases and associated merchandising. However, the anticipation built around postponed releases may amplify consumer demand when these movies eventually hit theaters. This deferred demand could create tailwinds for the collectible toy industry in 2024 and 2025, as pent-up anticipation for film-related merchandise is expected to drive strong sales once the strikes are resolved and normal release schedules resume.

Furthermore, the return to cinemas after the industry strikes could coincide with a resurgence of interest in movie-going as an experience, likely invigorating consumer enthusiasm for film franchises and by extension, for collectibles. This rebound effect may see an even more pronounced spike in demand for licensed property-based collectibles, as consumers celebrate the return of their beloved cinematic experiences with the purchase of memorabilia.

In summary, the box office performance in 2023 indicates a thriving interest in franchise films, which is closely tied to the success of the licensed property-based collectibles market. While industry strikes may have caused a temporary disruption, the anticipation for delayed releases could set the stage for significant growth in collectible toy sales in the subsequent years, reinforcing the strong connection between box office success and the market for film-related merchandise.

Forecast and Valuation

Funko is undergoing a pivotal transformation, addressing previous execution missteps to capitalize on the persistent demand for collectibles. Despite setbacks, the core business model and brand identity remain strong, and the company is strategically refocusing to leverage its unique position in the expansive collectibles market. Funko’s commitment to streamlining its product range, enhancing direct sales channels, and embracing an omnichannel strategy presents a significant opportunity to diversify revenue and regain momentum.

The company's adaptability, reinforced by its recent strategic adjustments, positions it well to exploit the massive and expanding Collectibles Total Addressable Market (TAM). The market has underestimated Funko's resilience and potential growth trajectory, overshadowed by past operational challenges. However, the inherent value of its core business and brand, coupled with strategic changes, suggests a bright future for Funko as it returns to its roots and capitalizes on the thriving collectibles market.