What was your first experience with valuation and markets? Was it a college finance class? Perhaps if you’re a millennial, the Global Financial Crisis aroused your interest. Some may have grown up in the shadow of the world’s financial center, and this industry has been at the core of their parents’ or grandparents’ livelihood. However, suppose you think back as far as you can. In that case, there’s probably a decent chance that the very first ‘market activity,’ and we’re being philosophical, not literal,  you might have experienced was haggling over baseball cards.

Generations of people grew up coveting, trading, and purchasing baseball cards. They were initially given out accompanying cigarettes. When children began flocking smokers for the cards, a perennial trend was born. Topps Chewing Gum sold the first modern baseball cards with packs of gum in 1952. Their popularity grew with baseball and has since blossomed into a virtual alternative asset class.

Our Signal From Noise column is predicated on finding alpha for our subscribers, and given the changing composition in methods by which companies  float their equity, we thought it was time to highlight a SPAC. Some of these deals have deserved notoriety due to aggressive forecasting, concept-driven rather than cashflow-driven investment, and more imagination than financial soundness. The name we found is not one of these SPACs.

Source: Topps Investor Presentation

The Topps deal with Mudrick Capital mixes a very traditional, conservative asset with exciting blockchain technology in  a way that is game-changing for profitability, yet this is not the lynchpin on which being a viable investment depends. Growth assumptions are not fantastical like some SPACs have become known for. An example would be that many EV SPACs predict to be worth $10 bn on a timeline that not even Google, one of the most successful companies in human history, could pull off. We urge you to reserve your pre-conceived notions (as is always desirable when evaluating a potential investment) of SPACs derived from facts like this to evaluate the idiosyncratic case for this particular investment.

Source: Topps Investor Presentation

An Iconic Brand With Valuable Consumer Connection Meets The Blockchain

We have stumbled across a deal that meets many modern themes that we like while also having some very conservative aspects that reliably produce steady cash flow.  It pairs what might get a reputation as an entirely speculative element by some assessments or an indispensable tool for monetizing digital scarcity depending on who you talk to, Non-Fungible Tokens (NFTs), with a brand that can evoke emotion in the hearts of millions of consumers on par with Disney in their former CEO Michael Eisner’s words. At the 30,000 feet, this deal is reminiscent of Barry Diller’s efforts with MGM-1.07%  in capitalizing on a strong and well-established physical business’s transition from the analog world to the digital one.

Source: Topps Investor Presentation

This is a particularly special opportunity if you love baseball or grew up collecting cards. Still, even if you didn’t, we try to demonstrate why we think this is a reasonably priced investment with significant upside and multiple growth opportunities that aren’t over modeled on or required to attain solvency like many SPACs. The underlying business of selling physical cards is in a definite upswing. In the first quarter EBAY saw the market for trading cards eclipse $1 billion and even more importantly active users doubled.

This bodes very well for this SPAC. Also, there’s no bubble in selling  bubble gum. The company has a respectable confectionary business with margins and brand recognition that are pretty appealing. This accounts for over a third of revenue. An accretive merger here is another potential sweet surprise for shareholders and could materially contribute to growth. All the businesses are at least competitive and in many cases exceed peers by many metrics.

Source: Topps Investor Presentation

Despite Reputation of Aggressive SPACs, It Is An Important Trend In The Equity Asset Class

Special Purpose Acquisition Companies have grown in popularity recently. They are a less cumbersome way than Initial Public Offerings (IPOs) of taking firms public, resulting in publicly traded equity shares. Some could describe the process as the result of a squabble between Wall Street and Silicon Valley, the latter of the two quite sick of paying steep fees. So far, in 2021, 84 companies have announced they will float using SPAC mergers, and 123 are using IPOs, so this is becoming more consequential for the equity asset class.

On the bright side they give retail investors access to businesses they might not otherwise be able to invest in and have lower fees, which can in turn lower Weighted Average Cost of Capital (WACC). The other side of the coin is the reckless techniques in promotion and valuation that have been seen in some SPAC deals sometimes to the detriment of investors. The company’s established and defensible position and unique niche in Sports and Entertainment significantly mitigates risk in our view. Also, we believe there’s no way a ‘shakeout’ in the high-growth area of NFTs topples Topps. Not going to happen. It’s all upside, in our opinion.

Source: Topps Investor Presentation

SPACs tend to involve two types of candidates; strong companies with established businesses that have traded in private markets for years and exciting companies that could often more reasonably be called concepts whose valuation is dependent on the realization of pretty aggressive growth assumptions. The company being taken public via merger, in this case, makes real money selling chewing gum, ring pops, and sports collectibles/trading cards. The brand is synonymous with baseball cards in the American psyche but its sources of revenue and brand partners are diverse and steady.

Source: Topps Investor Presentation

 It posted sales of $567 million in 2020, which was up 23% YoY. This was the third consecutive year of growth. This was all before the firm started expanding its prowess in physical products into the digital world by offering NFT cards. The success so far has been pretty incredible after only weeks of being live. While some may consider NFT the epitome of hype, others like Michael Eisner see serious opportunity. The success of NBA Top Shots is an example of consumers developing an organic market. The same is already occurring with Topp’s NFT efforts. What is pretty cool about this opportunity is that this management team has managed to get you some pretty impressive upside in the NFT space in an incredibly lucrative and capital-light fashion.

Source: Topps Investor Presentation

Collectibles Boom When Consumer Balance Sheets Do (80s and 90s)

The initial numbers on collectibles and trading cards are suggesting we are in the biggest bull market for these alternative assets since the boom in the 80s and 90s. If you are to purchase share in MUDS, they will eventually trade on a share-for-share basis under the new TOPP ticker when the deal is complete in a few months. The thing we like about this investment is that without the exciting upside and growth areas in its Digital Sports & Entertainment, Gift Cards, and upside potential in NFTs, it would still be a robust and steady business with desirable cash flow. CAPEX is next to nothing (about the cost of a decent house in California per annum), and this company has a fortress of content that it regularly monetizes and a significantly durable advantage in exclusive partnerships and contracts.

Source: Topps Investor Presentation

This company’s proverbial fortress of content is paired with eight decades worth of experience in monetizing it. Though best known for its physical baseball cards, it offers a vast spectrum of content to a very internationally diverse audience through partnerships and licensing. In addition to everything else this company is, it is a nuts and bolts content and licensing entertainment play with very credible plans for international expansion and the clout, relationships, and experience to implement a plan that rewards shareholders. Remember this is not in the high-growth side, it has profitable existing business growing in its own rite separate from grand plans.

 There are more intangible assets than trust-building exercises or whatever happens on the Google campus. The old-fashioned kind comes with having an irreplaceable brand and a direct connection to the heartstrings of dedicated consumers. Topps is chock-full of that kind of intangible value and we think when a conservative asset like this is mixed with a high-risk, high-reward one the risk/reward profile becomes appealing.

One of the benefits of this deal is also that unlike many SPACs, the financial success and interest of shareholders is not solely dependent on NFTs taking off. In fact, these things are so new that they are not included in the forecasts in a meaningful way despite their game-changing implications for the business. So, you’re getting this upside basically for free. The Topps NFTs have only been available for less than a month and the volume and amount of users so far indicates their foray will be immensely successful. This is probably why Michael Eisner has decided to keep all his shares despite nearly tripling his 2007 investment.

Let us explain why it is so consequential. Right now when they release physical baseball cards, all in after all costs they are getting about a 20% profit margin. The cards they sell then go on to sell for multiples of the original price on the secondary market. In the physical market, they do not get a piece of this side of the business that has remained elusive to them but where prices are significantly higher. With NFT’s they will get perpetual royalties from every subsequent secondary market transaction. Their revenue literally just grows as the market does and it’s a much higher margin segment. With the additional revenue and reduced costs the profit margin triples and goes to 60% when selling NFTs. This is game changing even if it takes a while to successfully migrate the physical business to NFT.

When you think of it that way and pair the exciting growth opportunities, this seems relatively cheap. The most similar recent play would be PLBY and look at how it has performed. We’re thinking for monetization purposes, particularly since PLBY completely abandoned its legacy business, the Topps brand is just as compelling if not more so since its existing business segments are profitable and growing. Also, virtually no CAPEX is required, which means this name is trading at only around 13x un-levered FCF and about 14x the adjusted 2021 EBITDA target.

Topps Recent History and Michael Eisner’s Involvement

The year 2007 was pretty instrumental for the investing world. Far away were the days of SPACs and NFTs. A little-known saga of this year was that hedge funds on Wall Street were besieging a true American darling, baseball card, and confectionary making Topps. A mighty white knight organized a way to save the beloved company. A private equity firm called Madison Dearborn Partners LLC partnered with freshly former Walt Disney CEO Michael Eisner to purchase the iconic baseball card maker Topps for $385 million. Many have never been in the position of tripling an investment of such a prodigious size, but it stands to reason that not cashing in would require great confidence in the plan going forward.

Their partner is required by covenant to exit, but as we noted Eisner isn’t selling a share. Even more impressive is that his partner Mudrick Capital is voluntarily committing an additional $100 million of its own money to the investment, a rarity for SPAC deals in which partners usually want to take the money and run! The insider enthusiasm bodes well for this fixture of Americana.

Risks And Where We Could Be Wrong

It is possible that the upside in NFTs never materializes and that it proves to be a passing fad. However, we and our very experienced crypto team think is unlikely. Scarcity is scarcity and it is the same thing that makes one nearly identical glossy baseball card printed on cardboard worth significantly more than the other. Its application in the digital realm is important and nascent and we think the model that Topps and Mudrick Capital have developed going forward is incredibly lucrative and will likely be beneficial to shareholders. As we stated, we think downside risk is significantly mitigated by the entrenched position of the legacy businesses and powerful brand value and recognition. Even more so, like many Epicenter names this company has a special relationship with its consumers that has persisted through all the turmoil the 20^th century could muster. We think it will last well into the 21^st in a reinvigorated, and more profitable fashion as well.

There is of course also the risk that the height of interest in trading cards and sports collectibles has for some reason passed and the company’s revenue will slowly fade. We find this unlikely. We think there are definitely risks to the cycles of valuation in what can be a wild market. As Topps begins to get more revenue from secondary market transactions it will become more exposed to the underlying cyclicality of the pricing of the digital collectibles.