Action Performance ATN W
February 25, 2004 - 10:41pm EST by
dr123
2004 2005
Price: 13.85 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 256 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

I recommend shorting Action Performance Companies Inc. (ATN), a leading seller of Nascar diecast (toy cars), apparel, and souvenirs. This stock is worth $7, at best, and yet remains in the teens because the market believes mgmt’s guidance of $1.50-$1.75 in 2004. The lowest estimate on the Street for diluted EPS is $0.80 and my belief is that $0.80 is a best-case scenario that has a small (say 5%) chance of happening. I also do not see anything in 2005 that will cause it to differ from 2004, ie my fy04 estimates are the same for fy05.

Even if ATN hits $0.80, however, the stock should drop to $7 (at least) because people will realize that this business is in severe decline. $0.80 in EPS would represent a 40% decline from FY03 EPS of $1.33, down 45% from the $2.41 in FY02 EPS. So for a business in severe decline, an appropriate P/E is probably 6-8, which yields a price range of $4.80 to $6.40

Current price: $13.85
My estimated FY04 EPS: $.86
P/E based on my estimated FY04 EPS: 16.1
Low end of mgt guidance: $1.50
P/E based on low end of mgt guidance: 9.2

My view is that mgmt not only lacks credibility but business is in shambles, both of which may explain why mgmt is not speaking to anyone (at least anyone that I know, including analysts).

I believe that ATN, at best (say a 5% chance), will earn $0.86 in 2004. I think there is a 70% chance they earn between $.30 and $.72, and a 25% chance they earn $0 or less.

My 3-scenario-EPS conclusion above is based on conversations with more than 30 large/significant industry participants over the last 9 months, my analysis of Nascar diecast sales on Ebay by driver and year of car (ie 2003 Dale Earnhardt Jr. car vs 2002 Jeff Gordon car), and ATN’s financials, whose shambles are obfuscated by acquisitions. By financials I also mean transcripts of ATN’s conference calls where the company's excuses for missing guidance, usually quantified deferral of rev, fail to show up in the 10q’s.

The history: ATN, per its website, “ is the leader in the design, marketing, promotion and distribution of licensed motorsports merchandise. Its products include a broad range of motorsports-related die-cast car replica collectibles, apparel, souvenirs and other memorabilia. The company markets and distributes products through a variety of channels, including trackside at racing events, a worldwide network of wholesale distributors and specialty dealers, QVC, the Racing Collectables Club of America (RCCA), www.goracing.com, and mass retail department stores and chains.”

ATN has been in business (as a public company) since the early 90s. From 1993 to 1999, ATN did well, growing revs from $15m to $342m and EPS from -$0.20 to $1.65, respectively. In 2000, however, the business hit a wall, revs dropped to $255m and net income was -$3.52 (EBIT was -$50m). 2001 would have been a bust as well (as of Jan 4 2001, Advest was predicting $0.24 in EPS while the company was guiding to $0.40-$0.50), but Dale Earnhardt Sr.’s death on Feb 18th, 2001, spiked demand such that ATN had a great 2001, generating $1.37 and $2.41 in 2002. One might wonder why the fad lasted through 2002; ATN was not able to respond to the increased demand after Earnhardt Sr’s death because of the long lead times necessary to make diecast. Also, increased TV coverage in 2001 helped. Therefore, it was only by 2002 that the company had fully ramped production to meet demand. But in 2003 the fad started to wear off again, causing organic revs (ex 2002 acquisition rev) to drop from $406m in fy02 to $357m in fy03. ATN accelerated the fading of the fad by oversupplying the market, and so in fy04, ATN is again seeing its business go bust.

The industry now: ATN does most of its business in the US (they sell in Germany, but that business is also deteriorating if you hold fx constant and is overstated by about 18% because of the appreciation of the euro vs the dollar; more on that later). ATN sells diecast cars and apparel to 17 distributors who in turn sell to thousands of retailers nationwide (they also sell trackside; more on that later). The basic problem with ATN’s US business is oversupply.

Data from industry participants: Over the last 9 months, I’ve spoken to about 30 sellers of Nascar diecast and apparel and 85% of them say that business is bad (down 25-30% in revs) both in the store and on their websites and they do not see conditions changing because they have not seen ATN decrease supply enough (ATN has decreased some but not enough). The 15% that are happy tend to sell cars on a pre-order basis via their websites, ie they only order cars for which they have pre-orders. Everyone says that ATN makes too many types of cars per driver and produces too much of each type. Collectors also give up collecting because ATN double-dips, it reproduces large quantities of rare cars.

I spoke with one large participant who said that he did not even go to Daytona to sell trackside because he felt ATN and others would be dumping product. He said that large veteran trackside vendors lost money at Daytona, not selling enough product profitably to offset the expenses involved with selling there, ie motel, food, and gas.

Talk to any seller of Nascar diecast and apparel and eventually the conversation boils down to ATN oversupplying the market and Ebay being the backdoor through which the excess supply (ie that not sold through the retail channel) is sold. There are two key points to understanding Ebay’s effect on the industry. First price: a typical diecast (even the newer pieces of the most popular drivers) on Ebay sells for distributor cost, ie the amount a distributor pays to buy from ATN, about $35-40. Second is the speed with which such inventory shows up on Ebay. 2004 diecast have already been on Ebay for weeks and they were not supposed to be shipped by ATN before Jan 2004.

Collectors have given up collecting because the oversupply destroys the value of the pieces they buy and/or they can never buy all of the pieces of a single driver. Those that have not given up collecting just wait a week or two to buy on Ebay.

Trends on Ebay: If one tracks sales of Nascar diecast on ebay, one can confirm the mismatch of supply and demand in the industry. For instance, Dale Earnhardt Jr., who just won the Daytona 500, Nascar’s version of the Superbowl, and has been one of the most popular (and perhaps the most popular) Nascar drivers over the last 12 months, has his cars fetching $34.23 (based on a sample of 474 sales over the last month). In December 2003, that price was $36 (on 93 transactions), in October 2003, it was $28 (on 150 transactions), and in September of 2003, it was $24 (on 111 transactions). In Oct 2002, the analogous price was $52 (on 150 transactions) and the price weighted by sales per month through May 2003 (total transactions of 866) was $47.64. Even more interesting, however, is that his 2004 cars are fetching an average of $31.19 (based on a sample of 159 sales over the last month). This price is about $4 below the cost wholesalers pay and we’re talking about the cars of the winner of the biggest event in Nascar in 2004 (that just happened in early Feb) and perhaps the most popular Nascar driver since his late father.

The financials: If one separates organic revenues from acquisition revenues, one sees that this business is declining. I tracked sales by channel. I first segmented the business into Diecast and Apparel, which includes Souvenirs. The diecast segment breaks out into several channels: wholesale domestic diecast, wholesale Germany, Club, and Mass Retail. Apparel breaks out into Wholesale domestic apparel, trackside, and Mass Apparel. Two of the analysts covering this company have the same segmentation.

For a best-case scenario, I predict comparable revs (ex Funline) in fy04 will be $327m, down 12% from $370m in fy2003. On a per segment basis my rev predictions are:

Diecast:
Wholesale Domestic: FY03 rev of $102.3m dropping to $76.7m in FY04
Wholesale Germany: FY03 rev of $34.6m increasing to $36.4m in FY04 (FX driven)
Club: FY03 rev of $24.4m dropping to $20.7m in FY04
Mass Retail: FY03 rev of $22.1m increasing to $61.9m ($40m because of Funline)
Total Diecast: FY03 rev of $183.4m increasing to $195m in FY04
Total Diecast ex Funline: FY03 rev of $183.4m dropping to $155m in FY04

Apparel:
Wholesale Domestic: FY03 rev of $82.3m dropping to $72.4m in FY04
Trackside: FY03 rev of $52.5m dropping to $49.8m in FY04
Mass Retail: FY03 rev of $49.5m decreasing to $47.1m in FY04
Total Apparel: FY03 rev of $184.2m dropping to $169.3m
Other: FY03 rev of $3m dropping to $2.8m in FY04

TOTAL REV INCL FUNLINE: FY03 $370m dropping to $367m
TOTAL REV EX FUNLINE: FY03 $370m dropping to $327m (fy02 acqu had full fy03)


I think the 12% drop in revenue will reduce gross margin; I think 32% is a best case gross margin given the 33.6% gross margin in fy03 and the large drop in rev.

I will go through each channel to explain how I arrive at my total revenue and then discuss my reasoning behind margins to get to my EPS.

Diecast:

Wholesale Domestic diecast: In the first quarter of 2004, wholesale domestic diecast rev was down 43% relative to the reported revenue in the year previous quarter. I state “reported revenue in the year previous quarter” because the company claimed, on the q1fy04 conference call, that due to manufacturing problems, they had to defer $13m of diecast rev from q1fy04 to q2 and q3 of fy04. They also claimed that the dock strike in California, which hit them in their q4 of fy02, deferred $5.7m in diecast revenue from q4fy02 into q1fy03 (ie the company claimed it was not really revenue that should have been in q1fy03). Bottom line, netting the $5.7 against the $13, q1fy04 revenues should have been about $6.3m higher, or $28.3m. Though none of these incidents was mentioned in the q1fy04 10q, if we were to believe the company, then sales in q1fy04 were actually down 48%. I assumed sales would decline by 25% fy04 because historically the last 3 quarters had $20m more in sales than the 1st quarter. Therefore, if one rounds the 1st quarter to $12m and assumes the other three quarters each generate $12m and then add $20m (because the last 3 quarters generate $20m more than the 1st quarter), one gets $68m. I then gave ATN an $8.7m cushion (which gets me to a 25% decline) for things like Earnhardt Jr. winning Daytona 500. Bottom line, I get revs of $76.7m for this channel, down from $102.3m, a 25% decline.

Wholesale Germany: Wholesale Germany 2003 revs are overstated by about 18% . Per ATN’s 10K (page 32) : “the 17.7% increase in foreign diecast sales approximated the change in the average euro-to-US dollar exchange rate between 2003 and 2004.” Gross of currency, wholesale Germany declined 3% in 2003 vs 2002. Due to the still weak and possibly weaker dollar, I assume wholesale Germany grows by 3.1% to $35.7m.

Club: Club was down 37% in q1fy04. I assume (guess) Club will be down 15% (probably more, but I’m being conservative in my short thesis) to $20.7m in fy04.

Mass Retail Diecast: Mass retail diecast was up 35% in q1fy04. Upon superficial inspection, one might say that this channel offers some hope to ATN. Yet looking closer, one sees that the q1fy04 rev number of $17.8m reported is not comparable to the $13.2m of q1fy04 because it includes $13.19m of sales from an acquisition made in Sept 2003 called Funline, which only sells non-Nascar diecast in the mass market channel. If one backs out this rev, one sees that the Mass retail diecast ex Funline (ie ATN’s organic mass market sales) dropped to $4.65m in q1fy04 from $13.21m in q1fy03, a 65% drop.

Mass Retail ex Funline: For fy04 Mass Retail ex Funline revs, I projected $21.9m, a 1% drop versus fy03. My reasoning is that fy03 was unusual for mass retail diecast because Walmart, ATN’s largest customer, stopped asking for product from ATN. There seems to have been a disagreement between the two that halted business but that has been resolved. I, therefore, looked at fy02 as the latest normal year. Given that q1fy04 was down 39% from q1fy02, I projected that the remaining 3 quarters in fy04 would be 61% of the revs generated in this channel in those quarters in fy02.

For Funline I projected $40m based on the performance payout agreement in the fy03 10k and based on Funline’s q1fy04 sales of $13.2m versus the q1 range in such agreement of between $12-$17. The fy04 range in such agreement is $35m to $45m, so I assumed that because they hit the low end in q1fy04, they would probably not hit the high end for the year. To be conservative, I opted for the middle of the range.

Adding Funline of $40 and Mass Retail ex Funline of $21.9m, gives one $61.9m total revs for the mass diecast channel.

Total diecast then sums to $195m and total diecast ex funline is $155m, down 15% from the comparable number of $183m in fy03.

My last note re diecast is that the company cited deferrals of about $15m of diecast revenue in each of the first three quarters of 2003 to explain drops in revenue relative to 2002. None of these explanations came up in any of the 2003 10q’s.


Apparel:

Wholesale domestic apparel: Wholesale domestic apparel was $13.25m down 20.4% in q1fy04 from $16.66m in q1fy03. The $16.66m, however, had $6.266m of acquired revs from companies acquired between June and September of fy02, so the real organic number was $10.393m, down 22% from the $13.2m of fy02. Despite this 22% from q1fy02, this channel’s revs, ex acquisitions, remained flat at $60.7m in fy03 vs $61.0m in fy02. So one could argue that the 20.4% drop in the 1st quarter is not indicative of the full year’s rev performance. I believe that q1fy04 rev decline predicts a 10% decline for fy04 vs fy03, implying $74m.

My reasoning for the 10% decline is that the nonacquired business continues to decline significantly while the business acquired in fy02 are declining at a slower pace. The 3 acquisitions that ATN made in late fy02 (Hamilton, Trevco, and McArthur) generated $35m in total rev in fy03 (they only generated $12m in fy02 because of their acquisition late in fy02). In the disclosure re these acquisitions, ATN states that Hamilton generated $10m in fy02, Trevco’s expected sales in fy03 would be $9m, and McArthur generated $14m in rev in fy02. Given these businesses generated $35.5m in fy03 and probably (depending on whether Trevco generated $9m in fy02) generated $35m in fy02 and given ATN’s negative comments re Jeff Hamilton (“we have higher than desired levels of inventory”) and given industry experts observations about jacket sales happening at lower than cost, I believe these acquisition revs will decline, probably around 5-10%. The rest of the decline should come from the nonacquired business. If one assumes that the acquired business was flat in q1fy04 vs q1fy03, generating $6.3m, the core business would then generate the remainder of the $13.25m, or $7m, which would be down 33% from the $10.4m generated in q1fy04.

Trackside: I think trackside sales will be down 10% (based on discussions with industry contacts), maybe more, but I will project down 5% based on the decline in q1fy04. Such a decline for fy04 implies $50m in rev.

Mass Apparel: I think Mass Apparel revs, conservatively, will be down 5%. My reasoning is that Mass Apparel ex Acquired revs have been fairly consistent. They were $33.6m in fy02 and $35.6m in fy03. Q1fy04 was down 32% vs q1fy03 but up about 33% vs q1fy02, so I decided to take the average of fy02 and fy03 sales for the channel, thus giving me $34.6m. The remaining rev is acquired rev, which I believe will decline by 10%, so I estimated $12.5m, which is down 10% vs $13.8m in fy03. The sum of $34.6 and $12.5m is $47.1m, total revs for the mass apparel channel.

All of these apparel revs add up to $169.3m. There are “Other” Revs that estimate to be $2.8m, down 7% from fy03 because q1fy04 of $0.56m was down 7% vs q1fy03 of $0.6m.

Total Revenues, therefore, add to $367m, which includes $40m of Funline revs. ATN mgmt has stated that Funline would contribute between $0.10 and $0.15 to EPS in fy04. I also know Funline SG&A and so can exclude it (there are no other Funline expenses) to calculate an ATN ex Funline EPS.

Given that ATN had a 33.6% gross margin on $370m in rev, and given that q1fy04 had a 24.1% gross margin, which is 500bps lower than the lowest gross margin ATN experienced in fy03, I believe that ATN will have a fy04 maximum gross margin of 32% on roughly $327m of revs. This gross margin could be lower than 30%, but I’m being conservative.

Using a 32% gross margin, one gets $104m in gross profit. I’ve modeled SG&A to be $81.3m, a 3% reduction over fy03, even though SG&A in q1fy04, excluding Funline SG&A, was up 3%.

I increased amortization by 4.6% to $3.6m (because q1fy04 was up 4.6%), yielding an EBIT of $20.7m. I assumed interest expense of $1.7m, Fx gain of $1m, Earnings from JV of $1.7m and Other income of $0.7m, giving me Pretax income $22.4m.

ATN indicated in its q1fy04 10q that it anticipated a 37.8% tax rate for fy04, which implies Net Income of $13.9m. On 18.5m shares currently out, that net income translates into $0.72 in EPS, a best case scenario.

I estimate Funline EPS will be $0.12 because ATN discussed margin problems it experienced with Funline in q1fy04 in that q’s conference call and because it came in at the low end of the payout performance schedule for q1fy04, range being $12-$17m and Funline generating $13.1m.

Therefore, total EPS, best case, will be $0.84 plus or minus a few cents.

There is another way to derive EPS to check my $0.84 estimate. ATN gives EBIT margins in its Qs and Ks by 4 segments (I exclude Funline because I assume it will contribute $.12 in EPS and the 2003 EBIT margins I use below include close to $0 in Funline revs):

Domestic Diecast: in FY04, I estimate revs (ex Funline) of $119.3m (down 20%).
Domestic Apparel and Memorabilia: in FY04, I estimate revs of $169.3m (down 8%).
Foreign Diecast: in FY04, I estimate revs of $35.7m (up 3%)
Corporate and Other: in FY04, I estimate revs of -$29m (in fy03 it was -$29m, in fy02 it was -$27m, in fy01 it was -$24m).

The FY03 EBIT margins were as follows:

Domestic Diecast: 24.5%; I think FY04 EBIT margin will be 21% (my guess) at best. Using my FY04 EBIT margin and revs above I get an EBIT of $27.4m
Domestic Apparel and Memorabilia: 13.2%; I think FY04 EBIT margin will be 11% (my guess) at best. Using my FY04 EBIT margin and revs above, I get an EBIT of $18.62
Foreign Diecast: 17%; I think FY04 EBIT margin will be same. Using revs above I get an EBIT of $6.1m.
Corporate: I estimate EBIT burn of -$29m

If I add these up, I get $20.8m. As I mention above, .I assumed interest expense of $1.7m, Fx gain of $1m, Earnings from JV of $1.7m and Other income of $0.7m, which add to $1.7m.

So EBT comes to $22.45m. Using a tax rate of 37.8%, net income should be $14.0m, or $0.75 EPS on 18.5m shares. Adding Funline, one gets $0.87 in EPS.

Lastly, the balance sheet shows ominous trends re DSOs and Inventory days. The trends on their own are disturbing (given declining sales) but even more so given that this industry is time sensitive because once a driver falls out of popularity, say he stops winning races, that driver’s diecast and apparel have little value and are sold for low prices on Ebay. The numbers follow:

DSO’s:
Q1fy04: 69.6

Q4fy03: 55.3
Q3fy03: 52.1
Q2fy03: 50.6
Q1fy03: 47.2

Q4FY02: 51.0
Q3FY02: 41.2
Q2FY02: 37.9
Q1FY02: 42.3


Inventory days:
Q1fy04: 87

Q4fy03: 41.7
Q3fy03: 61.1
Q2fy03: 55.3
Q1fy03: 54.6

Q4fy02: 44.7
Q3fy02: 38.3
Q2fy02: 37.3
Q1fy02: 41.5

Catalyst

FY04 earnings being lower than the lowest estimate on the Street, which is already half of the mid-point of the EPS range to which ATN's mgmt is guiding.
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