JAKKS pacific just reported better than expected results. Although they are humming along at a nice pace, I thought I'd throw out a warning to any holders of JAKKS. By my accounting, JAKK has been in the red by 2.1 million dollars for the first half of this year, despite reporting income of $1.4 million. This is perfectly legal; I'm referring to the operating cash flow statement. This could simply be a reflection of seasonal trends in their business. However, generally income exceeds cash flow during the busy season, which JAKK is about to enter. If the company is still bleeding cash now, what will happen in a few months? I'm just saying that by looking at JAKK's financial statements, it appears that the company is on the way to having a secondary offering of stock. I say this for several reasons, some of which are general warning signs.
First, the cash position is very low, much like THQI's cash, for the several quarters prior to its secondary in early 1997.
Another reason is that JAKK has preferred stock outstanding, which should ultimately be redeemed (this would be in the best interest of common holders).
Third, JAKK has $6 million in covertible debentures, which will ultimately be converted. Of course, the company could need cash to redeem the notes and preferred shares, or these conversions will dilute common holders. Preferred stock and convertible debt is likely to be eliminated when a company's stock price gets high enough to make an equity offering attractive.
Fourth, half of JAKK's total assets are intangible assets, such as trademarks & goodwill. If JAKK finds that these items have been overvalued on the balance sheet, the company could take a substantial charge to earnings. This goes the same for operations, when receivables tend to grow much faster than sales: the potential for a write-off increases. After all, eventually, operating cash flow needs to approximate net income to some degree. If income is continually overstated, relative to cash flow, the chance for a "negative surprise" increases.
A simple glance suggests that JAKK would likely offer at least 1 million shares to make their balance sheet more solid.
Although the operating side of the business (sales & earnings) is very good, and growth is strong, there are some warning signs that may indicate problems on the horizon. But the long-term viability of the company is not likely in jeopardy, unless the story plays out like Thrustmaster (TMSR).
Slightly more than a year ago, I warned the TMSR thread that a secondary offering could be in the near future, based on the weak cash position of the company. I also said that THQI was a better investment, despite the fact that THQI looked fairly valued on forward EPS estimates, while TMSR was cheap. For a while, I looked kind of stupid, as TMSR proceeded to double, while THQI went up by 30-40% (I don't recall the exact dates or percentages) in the following few months.
But my hunch was correct that TMSR needed cash to prepare for its growing business, much as THQI needed it a few quarters before. The stock responded poorly to the announcement, and ultimately, the company pulled the planned offering off the table, due to the declining stock price. The company's insufficient cash flow, as well as general business conditions, adversely affected its operating results in the next few quarters. The stock has yet to recover, trading at $6, which is several points lower than when I mentioned my concerns in 1997. At the same time, while TMSR's earnings estimates were slashed, THQI blew through any and all estimates, and the stock has since tripled to $34.
The key is that a company which needs cash is at an advantage if it is public, but its disadvantage is that the price tends to drop after the announcement. Unless the offering can be done quickly, the price may get too low. Any offering at that point is terribly dilutive. Of course, GVIL tried to do a secondary at $3 and is now trading as OWLD for less than 65›. If the company can't complete the offering, it becomes endangered. The ability to pull off an offering, however painful in the near-term (such as THQI, who announced the deal at $9.5, and netted less than $7 per share a few months later), can be life-saving in the long-term (again, see THQI).
I'm not trying to be an alarmist, and I'm not mentioning all this to receive a compliment for my foresight. I'm doing this only to offer my analysis to shareholders of JAKK, because a similar set of events may ultimately unfold in the next few quarters.
Todd |
