(Bloomberg Gadfly) -- Funko, the purveyor of 2017's version of bobble-head dolls, appears to have a big head when it comes to its financial results.
Shares of the company priced on Wednesday night at $12 and are scheduled to begin trading on Thursday morning. The pricing was below the indicated range of $14 to $16, but even that may have been too high.
In Funko's IPO prospectus, in a chart with a big arrow pointing up, the company says that an important measure of its income, which it uses to determine the success of its operational strategies, rose by an average of 86 percent in its past two full years. The actual bottom line, though, was up an average of just 16 percent in 2015 and 2016 and has turned negative lately. Funko lost just more than $10 million in the first half of this year. How the toymaker gets a loss of $10 million to reflect back as an 86 percent earnings increase is the latest example of fun-house accounting on Wall Street.
Funko's main product, Pop! dolls, is hot. The plastic figures with enlarged heads cost about $10 each and are typically of popular characters from kids' movies or TV shows. But there are also Pop! figures based on athletes and characters from the popular HBO series "Game of Thrones." They have become fixtures at Gamestop and Barnes & Noble. (Full disclosure: My daughter's Pop! collection is nearing the entire population of Hogwarts, with Moana as a visiting student.) Sales of Pop! dolls grew an impressive 34 percent last year.
The question is how profitable the $10 figures are, if at all. Funko arrives at its 86 percent compounded annual earnings growth rate by focusing on a figure that more and more companies point their shareholders to called adjusted Ebitda, which excludes a number of costs. Each company computes the figure slightly differently, which is why many accounting experts hate it, but companies like Funko say it is a better measure of their operations. Let's see.
Funko says it had $97 million in adjusted Ebitda earnings in 2016, up from just $28 million in 2014, an increase of $69 million. How did it manage that increase? Two years ago, Funko was sold to a private equity firm. Funko says acquisitions are a one-time expense, even though it says it plans to do more deals in the future. Nonetheless, exclude those costs, and the company's adjusted Ebitda jumps nearly $25 million. Funko also contends it has intellectual property worth $250 million. That's odd for a company whose main products are based on others' intellectual property. Anyway, the company stepped up write-offs of that intellectual property last year. Depreciation costs rose $19.5 million. But Funko says that cost is not part of its operations and excludes it from its adjusted Ebitda, causing that figure to rise once again. Funko has also piled on debt in the past two years, in part because of its private equity ownership. Interest expense rose $14.5 million, which is also excluded from adjusted Ebitda. You get the picture; the higher cost is reflected back as better earnings once it's excluded.
The result, just $7 million, or 10 percent, of Funko's $69 million increase in adjusted Ebitda -- which led to that 86 percent increase in growth from 2014 to 2016 -- was from actual earnings growth. The other 90 percent came from higher costs that the company says investors should just ignore. Funko Pop! dolls are based on fantasy. Its accounting shares a similar trait.
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Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.
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