The House That Hef Built

Playboy lately has been bedeviled by losses at its once-profitable magazine, competitive pressures in the U.S. television business and the proliferation of soft and hard-core pornography on TV and the Internet. The company last month warned Wall Street that its 2006 profits would be sharply below estimates, which sent the stock skidding from 13. Wall Street now looks for profits of about 25 cents a share, compared with prior projections of 65 to 70 cents, and earnings of 56 cents in 2005.

Yet, Playboy's fans argue that it is significantly undervalued, and that its online, TV and licensing opportunities in the U.S. and abroad should become more visible in coming quarters. "Playboy has a wonderful franchise and brand," says Mark Boyar, head of Mark Boyar & Co., a New York investment firm that owns the shares. "I don't think there's a single global media company with such a small market value."

Playboy has an equity-market value of just $310 million and net debt [debt minus cash] of $65 million. Boyar values the company at more than $20 a share.

Christie Hefner, 53, Hugh's daughter and Playboy's chief executive for the past 17 years, is predicting that second-half profits will be up 50% from the year-ago period. "If we deliver in the second half, I believe the stock will outperform," she said in a recent interview.

Next year, the company could earn 70 cents a share, and pre-tax cash flow could top $40 million, up from a projected $25 million this year.

With its skimpy market value, low debt levels, understated earnings and global brand recognition (who doesn't know the rabbit-head logo?), Playboy could be taken private by management or private-equity investors. (Big media companies likely would shy away because of the pornography association.) Private-equity types would be attracted to Playboy, says Boyar, in the belief they could run it better than Christie Hefner.

"Christie loves to spend money," he adds, citing the expenses associated with the company's headquarters in Chicago, offices in New York and Los Angeles, and Hugh Hefner's home, the Playboy mansion in L.A., which alone costs $3 million a year to run. Late last week, the company announced the acquisition of Club Jenna, the adult-entertainment media business founded by porn star Jenna Jameson.

With corporate overhead now running at $25 million annually, or about 7% of projected '06 revenue of $350 million, Boyar sees room to cut costs. Most media companies keep overhead to about 2% of revenues.

MICHAEL SAVNER, AN ANALYST at Bank of America Securities, recently upgraded Playboy to Buy from Neutral, and set a $13 price target. "We would not rule Playboy out as an LBO [leveraged buyout] or MBO [management buyout] candidate," he said in a client note, adding that the potential for either transaction could put a floor under the stock.

Christie Hefner says the company isn't for sale, and that her father believes Playboy is "best served as a family-controlled company." She argues, as well, that the company's expense base is "about right", and calls it the price of being a small, diversified media conglomerate.

While a sale might be a long shot while Hugh Hefner is alive, the situation could change on his death. Hefner remains in good health, his daughter says, adding that Hef's mother lived to 101. Hugh Hefner controls about a third of Playboy's 33 million shares, including 70% of the thinly traded voting shares (PLA/A).

Boyar and others are critical of the company's decision not to repurchase stock at current levels with some of its $52 million in cash. "What better use is there of corporate cash when the stock is trading at half its intrinsic value?," Boyar says. Christie Hefner counters that Playboy would rather invest in its business.

Playboy is an unusual mixture of mainstream entertainment and pornography, whose offerings encompass cable shows like The Girls Next Door on the E! network, soft-core Playboy TV channel and the hard-core Spice and Hot Zone TV networks. To those who say the company's image has become dated, Christie Hefner counters that the brand "has never been hotter" in her 30 years' tenure. She points to the success of The Girls Next Door, the highest-rated show on E! during its first season. The program features the exploits of Hef and his three girlfriends, Kendra, Holly and Bridget.

Beyond its media properties, Playboy has partnered with the Palms hotel/casino in Las Vegas for a Playboy casino and nightclub in a new tower that's due to open in September. That deal should net the company $3 million in annual profit, and set the stage for possible partnerships with casino operators in Macau and London.

Hef okayed an updated bunny outfit that will be worn by cocktail waitresses at the Palms, which is popular with a young, hip crowd. With the Palms and other deals, Playboy is creating a valuable stream of licensing profits, which could hit $19 million this year, nearly double the total in 2004.