4 Kids Entertainment (KDE): A Stock Selling Below Cash or Fad Stock?
Business Description
4 Kids calls itself a diversified entertainment and media company specializing in the youth oriented market, but is better classified as a patent owner/lessor. The company operates in 4 business segments:
(1) Licensing
(2) Advertising Media & Broadcast
(3) Television and Film Production/ Distribution
(4) Trading Card & Game Distribution
Story Line
4 Kids Entertainment may make for an interesting short sale candidate. There were high expectations surrounding its Chaotic Trading Card Game, something described as Pokemon meets Webkinz. I don’t think it can get much more faddish than this, but it does. 4 Kids has licenses for Cabbage Patch Kids and Teenage Mutant Ninja Turtles, among other washed up fads.
I admit that when I first looked at 4 Kids, it seemed to have a somewhat compelling business model that had potential for high returns on capital and low capex. However, a quick peruse through the company’s recent 10-K would have shown that the company was a lot more capital intensive than meets the eye. A lot of people probably got burned because they failed to factor in off balance sheet financing decisions. 4 Kids looked more conservatively financed than it really is.
Fine you say, the balance sheet isn’t as good as originally thought, but what about the Chaotic catalyst? The Chaotic game may take off and produce a strong revenue stream in the short run, but I believe that the long run revenue streams are quite predictable here in that they are probably non-existent. Although the Chaotic catalyst has likely been factored out of the share price, the potential upside here, which is meager at best, still doesn’t offset my worries about the company’s liquidity issues.
Balance Sheet Analysis
4 Kids Entertainment (KDE) is yet another micro-cap name that appears to sell below cash, but upon further analysis, maybe not. The company has a market cap of $26.72M and cash of $40.92M with no debt, but substantial contractual commitments ($124M not discounted) that consist of operating leases as well as television leases with CW and Fox, so the company’s leverage is understated.
4 Kids also has illiquid auction rate securities (ARS) on its books that the company has had to mark down. The ARS were purchased at the discretion the company gave to Lehman Brothers, had to be marked down to Level 3 securities because of the credit crisis, and as a result the company is currently assessing what additional steps to take to pursue legal redress. My question to management is why this was delegated to Lehman Brother’s discretion in the first place, why not put cash into treasuries (unless this was the mandate and Lehman completely ignored it)?
The most recent 10-Q says that the company remains well funded, but lacks the ability to expand its business because of the mark downs in its auction rate securities. I’m not so sure as there are some substantial payments that need to be made over the next year according to the 2007 10-k:
Year Ending December 31, |
CW Agreement |
4Kids TV Broadcast Agreement |
Operating Leases |
Total |
2008 |
$6,750 |
$20,000 |
$ 2,706 |
$29,456 |
2009 |
15,000 |
15,000 |
2,442 |
32,442 |
2010 |
15,000 |
— |
1,871 |
16,871 |
2011 |
15,000 |
— |
1,075 |
16,075 |
2012 |
15,000 |
— |
971 |
15,971 |
2013 and after |
8,250 |
— |
5,286 |
13,536 |
Total |
$75,000 |
$35,000 |
$14,351 |
$124,351 |
Looking at this, even without discounting anything, makes me feel that 4 Kids Entertainment would make for a poor credit. The company burned through $16M in cash last quarter, and has burned through about $50M+ since Fall of 2007.
Some circumstances have changed as the litigation with Fox has been settled, and 4Kids will terminate its agreement with Fox, and the remaining financial obligations to Fox will also terminate. Next year the company will still need to pay about $17M or so and the company has not been generating operating cash flow over the last 4 quarters. Management has thought about this and has decided to cut staff by 15% across all subsidiaries, which will save an estimated $4M-$5M, and combined with the termination of the Fox agreement will altogether save about $15M-$18M.
So this gives KDE some breathing room, but other cash outflows remain. Assuming SG&A expenses of around 85% of current levels would still amount to a cash outflow of around $12M per quarter, or $48M in FY2009. The company only has $41M of cash on its balance sheet, and net working capital of -12.58M.