There's a new challenger entering the ring in China's wildly popular collectible toy market. Here Group Ltd. (HERE), a company that just months ago was teaching adults and is now making pop toys, wants you to know that its Wakuku character franchise is coming for Labubu's crown.

That's a bold statement considering Here Group's toy business is still a tiny fraction of what Pop Mart (9992.HK), owner of the Labubu phenomenon, pulls in. But the company formerly known as QuantaSing isn't lacking in ambition as it pivots hard into one of the hottest consumer trends in Asia.

A Complete Business Transformation

Here Group only jumped into the pop toy game this year through its acquisition of Shenzhen Yiqi Culture Ltd., also known as Letsvan, which owns the Wakuku franchise that launched just a year ago. The company hasn't wasted any time diving into this new business, rolling out aggressive promotions and plotting a network of physical retail stores.

After announcing plans to sell off its adult education business in September, the company's latest quarterly report released last week represents its first as a pure pop toy play. To complete the transformation, it ditched the QuantaSing name and ticker symbol, relaunching as Here Group on November 11.

The strategic shift makes sense when you consider the regulatory environment in China. Education has become increasingly risky territory due to potential government crackdowns. While Here Group's focus on adult education made it somewhat safer than primary education, which got hammered by regulators four years ago in a crackdown that obliterated the entire after-school tutoring industry, why take the risk?

Pop toys carry less regulatory risk, though they come with their own challenges. The market is notoriously fickle. Characters that explode in popularity can fade just as quickly, which appears to be happening right now to Labubu after its summer surge. Success in this space requires constantly discovering and promoting new intellectual property to keep revenue flowing.

The High-Stakes IP Gamble

Here's where Here Group's strategy gets interesting and risky. Unlike other pop toy makers, the company is betting almost exclusively on self-developed and exclusively licensed characters. Compare that to rivals like Bloks (0325.HK), Miniso's (MNSO.US; 9896.HK) Top Toy, and even Pop Mart itself, which use a mix of proprietary IPs and non-exclusive licensing deals with major franchises like Disney (DIS.US) and Japan's Sanrio (8136.T), the company behind Hello Kitty.

During its first earnings call as a pure pop toy company last week, Here Group executives revealed that nearly all of its 127 million yuan ($18 million) in revenue for the quarter ending in September came from just three proprietary IPs. The Wakuku franchise alone accounted for 71% of revenue, with another older character called Ziyuli contributing 16%. Together, these three homegrown franchises delivered 97% of total sales.

Owning your IPs exclusively has major advantages, particularly when it comes to margins. You don't have to pay expensive licensing fees or share revenue from merchandise sales. But it also means the entire burden of popularizing these characters falls on you. Unlike licensing Hello Kitty, which already has massive global recognition and built-in demand, you're starting from zero and need to spend heavily on marketing to build awareness.

Strong Initial Growth Numbers

The financial results show Here Group's aggressive approach is generating momentum. That 127 million yuan in revenue for the three months through September represents nearly double the 65.8 million yuan the toy business generated in the previous quarter ending in June.

Looking ahead, the company expects revenue to continue climbing to between 150 million yuan and 160 million yuan in the current quarter through December. That implies quarter-over-quarter growth of about 22%, a slower pace but likely due to seasonal factors. For its full fiscal year running through next September, Here Group projects revenue of 750 million yuan to 800 million yuan. Do the math and that means roughly 500 million yuan in the second half of the fiscal year, nearly double the approximately 280 million yuan expected in the first half.

Stock Performance and Valuation

Here Group's stock has been moving largely in tandem with Pop Mart's since announcing its toy business pivot early this year. The shares initially exploded, climbing as much as sixfold from their January levels to peak in mid-June. They've since fallen more than 60% from that high, though they're still trading at more than double where they started the year. Pop Mart has followed a similar pattern, with shares more than tripling this year to a peak in mid-August before falling over 40%. They too remain more than double their starting point for the year.

From a valuation standpoint, Here Group looks like it has substantial upside if it delivers on its growth promises. The stock currently trades at a price-to-sales ratio of about 2.5, based on projected revenue for its first full year as a toy company. That's just one-quarter of Pop Mart's 10.3 P/S ratio, and less than half of Bloks' 6.11 multiple.

Building the Business Infrastructure

Chairman and founder Li Peng laid out the company's marketing strategy during the earnings call, detailing several initiatives to build brand awareness. These include launching a themed street in Shanghai and forming a partnership with Beijing's state-run TV and radio station operator, which the company believes could serve as a template for similar partnerships across China. Here Group has also opened its first physical stores in Beijing and Chongqing, with plans to expand that retail footprint next year.

Right now the business remains largely concentrated in China, but the company has already laid groundwork for eventual international expansion by establishing operations in 20 other markets.

Margins and Profitability

There are some encouraging signs in the company's profit margins. Gross margin for the toy business improved to 41.2% in the latest quarter from 34.7% in the previous quarter. However, both figures still trail significantly behind Pop Mart's 66.8% gross margin for all of 2024. Investors will be watching closely to see if that gap narrows as Here Group's business scales up.

Profitability remains elusive for now. The company reported an adjusted net loss from operations of 17.1 million yuan for the latest quarter, a slight improvement from the 19.3 million yuan loss in the previous period. Getting to profitability will be another key metric investors monitor as the company continues building out its toy empire.

The bottom line? Here Group is making a bold bet on the collectible toy craze with an even bolder strategy of going all-in on proprietary characters. The early growth numbers look promising, the valuation offers plenty of room for appreciation, and the company is aggressively building out the infrastructure needed to compete. Whether Wakuku can truly challenge Labubu remains to be seen, but this is definitely a story worth watching as it unfolds.