Description

Confidence is key to maintaining a stock price. The story of KDE is a saga of confidence: the market believed in Pokemon (a children’s media and toy phenomenon) a year ago and KDE was at 93; today the faith is long gone and KDE languishes at 13 7/16.

Yet year over year comparisons for the most recent 4 quarters have all been records with annual earnings growth for the period over 700%! In just the last 6 months, net cash has climbed from $17M to $76M ($6.37/share) in what are historically the slow quarters of the year. So for just over $7 net per share, you can own an earnings machine generating $3.11 in the last 12 months and, more importantly, it will likely far exceed those numbers in the next 12 months.

How can this be? Primarily it stems from lack of confidence in the sustainability of earnings based on a 'fad'. The Street does not understand this company. KDE presently has no investment banking needs, and thus no ‘quid pro quo’ research has been initiated. (This will change as KDE begins to acquire properties). Only one obscure analyst follows it and her reporting commenced just last month with a neutral rating. The company strongly disagrees with her '00 second half earnings projections. Historically, KDE gets progressively stronger in the 3rd and 4th quarters as holiday revenues kick in. Here are the numbers:

EPS:

Quarter ending____’98____’99____’00

MAR____________.03____.07____.71
JUN____________.01____.16____.78
SEP____________.04____.54
DEC____________.18___1.08

The premise that Pokemon is finished continues to fuel a significant short position on the stock representing 42.3% of the float! There are two perceived risks: Is Pokemon, as a single ‘property’ representing 90% of current revenues, a one trick pony? Secondly, Hasbro, as a single licensee, represents 39% of the revenue stream. The latter results from toy industry consolidation and is a fact of the business.

So why would one want to go long now? Aside from the valuation, Pokemon is far from dead and in the future KDE will be far more than Pokemon.

The rumor of Pokemon’s demise is premature. Pokemon as a trading card, TV, film, video, music, and merchandising entity has run over 55 months in Japan, and remains strong. It is just over 24 months in the US, Canada, and Australia. It just began its merchandising penetration of Europe a year ago. KDE represents the property for worldwide licensing rights outside of Asia. It’s now in 66 countries and its popularity is universal. It's a global phenomenon at various stages of introduction, producing annuity-like revenue streams. These are much longer tailed revenue streams than a typical 'flash-in-the-pan fad'. An amazing 44 cents on the revenue dollar falls to the bottom line!

Nintendo of America has just launched the Gold and Silver Pokemon Game Boys and expects record sales of 10 million units by spring 2001. A major toy market researcher (covering 60% of the domestic market) indicates “Pokemon is as strong as ever”, and will increase with the Nintendo Game Boy introduction. The WB network has ordered 52 new episodes of Pokemon. Ratings are number one, domestically and internationally, in all their respective markets. A third movie is in the works for theatrical release next Easter, and the first movie recently came out on video. Revenues from the video and the second movie will begin to hit the books this quarter. A Live Pokemon theatrical launched at Radio City Music Hall and is now touring; it could go worldwide.

KDE is using the good fortune of the Pokemon platform to diversify into new properties and concepts, while sticking to the core business of licensing and media marketing. One can draw a parallel to pharmaceutical companies. The blockbuster drug makes your company, and then you invest in R&D to come up with the next one, and so on. This is the process for KDE now. They are not spending money to buy back stock, because they believe it is more valuable to invest in the business. Here is just some of the pipeline:

1)Cubix: TV launch January 2001.

2) Tama and Friends: Premieres September 2001.

3) KDE now represents Marvel comics in Europe.

4) Perfect Dark will launch a wide array of elements based on the Nintendo character.

5) Cabbage Patch entity will be relaunched in 2002.

KDE’s future clearly depends on continuing Pokemon revenues and development of new revenue sources. There is NO specific indicator pointing to Pokemon’s withering as a revenue source. Thus the near term looks good. There is every reason to believe that some of the efforts now underway will bear substantial fruit. While not risk free, the growing cash base points to a floor for the stock of this debt free company.

This is not your ‘typical’ value idea. Aside from the growing cash hoard, there is little in the way of tangible assets. It requires thinking outside the normal ‘value box’ to equate ‘virtual’ with ‘incredible margins’. At its core, KDE is a CONTENT provider to ANY distribution channel. The various outlets (toys, media, and merchandise) are just commodities, and Content, KDE’s ‘asset’, is the real source of value!

Catalyst

In the short term, it won’t take much to ignite this stock. Earnings will easily beat projections for the second half of this year, and a short squeeze could result. In the longer term, indications of success and sustainability by any of the new properties will eliminate the ‘just a fad’ perception, and promote an accurate reflection of operations and intrinsic value in the stock price.