JAKKs Pacific (“JAKK”) is down about 25% in the last 2 weeks and is currently trading at attractive levels; ~4.4x normalised EV/FCF and 2x Total Debt / FCF ( -$135 net debt). Stock got recently crushed after management revised guidance for the year (15% lower revenue estimates for the year) after sales in the beginning of the holiday season were disappointing.
Annual revenues revised to $660 mm from $770 mm estimated earlier
EPS expected to be ~$0.38 vs. $1.37
The significant revision in earning was unexpected by investors. Management didn’t give any indication of lower revenue estimates during its Q3 earnings call despite being questioned by an analyst specifically if the company could maintain revenues for the year.
Drew Crum - Stifel Nicolaus - Analyst: The revenue guidance you kept for 2011 would imply a pretty hefty increase in the fourth quarter, if my math is right – high teens type growth. Was there anything timing related in the third quarter that shifted revenue into the fourth quarter? Or could you explain what you are seeing for the fourth quarter behind the guidance?
Joel Bennett - JAKKS Pacific Inc - EVP, CFO: In general, we [can't time it]. And that's part of the reason why we don't give quarterly guidance, because there is a continuous flow. Sometimes it picks up sometimes it slows down. But what we do is monitor our POS information, rate of sale at retail and basket configurations and such. So we're on track for the year. But as we can't time the quarters, we don't give the quarterly guidance.
This is despite the fact that the company had to generate ~$230 mm in Q4 sales to meet annual revenue estimates ($198 mm in 2010 Q4). But two months into this call, management revises its Q4 estimate to ~$125 mm claiming disappointing product sales thus far in the holiday season triggering higher mark downs and royalty expenses.
Despite the poor handling by the management, the Company is fundamentally sound and the stock has good potential to be around $17 to $18 in the next 8 to 12 months. A quick background on the company and the industry before I delve into my thesis.
Company background: JAKKS Pacific is the 3rd largest toy-maker in US. Mainly operates in two product lines. 1) Traditional toys and Electronics – includes Dolls, Action Figures, Vehicles etc.; 2) Role Play, Novelty and Seasonal toys – include Role Play products, Halloween costumes, kids furniture and pool toys. Revenues are evenly split between both the product lines. Distribution channel is dominated by sales in store like Walmart, Target and Toys ‘R; Us. JAKKS currently distributes in over 65 countries with about $55 mm in revenues and is focused on expanding international distribution.
Industry: Market size for traditional toys is around $24 bn and has grown at a very slow rate in the last 10 years, mainly due to rapid industry growth in the video gaming and casino gaming industry. Though there are 1000s of toy manufactures, top 5 industry players dominate most of the market. Mattell has the largest market share ($6.2 bln revenues) followed by ($4.2 bln revenues). Though market growth is slow, product life for toys (Barbie doll, superhero characters etc.) are relatively longer than the video gaming industry products, making revenues less volatile.
Brief positive for the stock are:
Strong product pipeline for 2012: Market has been anticipating couple of new products from JAKK including Monsuno (JAKK owned IP expected to debut in spring 2012) and other entertainment tie-ups.
Strong balance sheet: Approx $235 mm (65% of market cap) in cash holdings. $100 mm of convertible unsecured debt (~3 years to maturity).
Strong fundamental investor following: In September, Oaktree expressed interest in acquiring the company for $20 per share (+38% to current stock price). The board of JAKK unanimously rejected the offer claiming the bid was inadequate. Excerpts from Q3 call “Our Board believes that this is not the right time to sell the Company and that the execution of the Company's strategic plan, including potentially transformative products planned and already underway, will provide significantly greater value to the Company’s stockholders”. I believe next time around the BOD would consider any such offers more seriously.
Acquisitions: with strong cash balance and low trading industry multiples, JAKK could find cheap targets to acquire and growth its product pipeline
There are couple of considerations to the price target:
Low consumer spending due to the ongoing economic uncertainty
Pipeline products are not successful as expected
Low insider holding: CEO and CFO hold negligible amount of the Company’s stock.
Dilution from convertible bond: Bond has a conversion price $15.64 (with 3 years life) beyond which it will be dilutive to the company. This is not a major concern to the company has it can always tender the bonds at the right time with available cash or refinancing with new debt at current low interest rates.
1. Better Q1 sales numbers,
2. Success of Monsuno, and other products in the pipeline..
3. New acquisition bid for JAKK by the likes of Oaktree