Description
The Company is divided into two businesses: Handleman Entertainment Resources (89% of sales) is a category manager and distributor of prerecorded music to mass merchants. North Coast Entertainment (12.5% of sales) is responsible for the Company's proprietary operations, which include music and video products, as well as licensing operations.
H.E.R. actively manages the selection, acquisition, display, sale and return of music products for unrelated mass merchant chain stores. The company purchases music from many different vendors, although a small number of major, financially sound vendors account for a high percentage of purchases.
NCE acquires and develops master recordings, exclusive licensing and distribution agreements and original productions. Many NCE products are categorized as budget, with many retailing for under $10. The division consists of three entities: Anchor Bay Entertainment (home video products), Madacy Entertainment Group (music recordings) and the Itsy Bitsy Entertainment Company (entertainment properties for children).
Kmart accounted for 35%, 31% and 33% of sales in 2000-1998. Wal-Mart accounted for 42%, 39% and 32% of sales in 2000-1998. These two customers also accounted for 63%, 66% and 45% of accounts receivable in 2000-1998. Handleman offers its customers a variety of value added services:
1) store service: sales representatives visit individual retail stores and meet with store management to discuss upcoming promotions, merchandising, current programs, inventory levels.
2) advertising: assists customers in preparing radio, television and print advertisements
3) fixturing and freight: provides specially designed fixtures that emphasize product visibility and coordinates delivery of product to each store.
4) product exchange: protects its continuing customers against product markdowns by offering the privilege of exchanging slower-selling selections according to seasonal and current selling trends.
Founded in 1934. Severe price competition in the mid-1990's led by Best Buy and Circuit City weakened and destroyed many music retailers and distributors. Handleman's profits topped out in 1993 and its sales growth stalled in 1995 due to this destructive price competition. In 1998, the company began a comprehensive strategic repositioning designed to focus the Company on its core music distribution business. The repositioning activities included employee severance (30% of employees) and warehouse closings. The repositioning is mostly complete.
Buybacks: Year to date, the company has repurchased 365,500 shares at an average price of $11.11. Since September 1997, the company has repurchased 7.5 million shares for over $80 million ($10.67/ share). HDL repurchased $42mn worth of shares in FY2000. This equates to 16% of current market cap. i.e. the company is cheap & it generates a ton of cash.
Market Share: Handleman has a 34.2% share of the US music category merchandising business. Its competitor is Anderson Merchandising (a private company) who also services Wal-Mart stores. Wal-Mart briefly attempted to merchandise its music department by itself when it acquired Western Distributors in 1991. In 1994, after disappointing results, Wal-Mart sold Western Distributors to Anderson Merchandisers. Music departments operated by Handleman generate higher sales and margins per square foot than the typical account's storewide average.
Management: owns 5.0% of shares outstanding. David Handlemen is still on the Board of Directors, but retired from the company in 1993. The current CEO, Stephen Strome has been with Handleman for 35 years and CEO since 1989.
The company trades for roughly 6x earnings and 5.5x earnings before goodwill amortization. EV multiples are as follows: 4x EBIT, 3.5x EBITDA, 26% of sales. The low multiple reflects concentration of customer risks and operational problems related to exited businesses. However, the discount is excessive in my mind due to 1) the company's long-standing relationships with core customers (with Wal Mart since 1972), 2) the fact that WMT tried to do it themselves already--and failed, and 3) competency in its core business (HDL has been distributing music since the 1950s). In my opinion, the legacy issues with respect to exited businesses are not relevant given that the operational problems related more to an extremely competitive market rather than poor execution on the part of management.
Intrinsic Value estimate:
Intrinsic value is roughly $20, using either a small discount to traded comparable companies such as Advance Marketing Services (MKT) or buyout values computed using factors such as cash flow generation.
Catalyst
As Walmart expands overseas, it has taken HDL with them. Most recently, HDL announced that it will begin music category management for WMT's Asda division in the UK. This is expected to add $100mn in sales on a run-rate basis. The growth from international expansion of its main account, and continued penetration by the mass merchandise segment should provide growth to HDL. (It should be noted, though, margin expansion will most
likely not occur given WMT's focus on costs.)
This growth could be a catalyst. But there is another: there is an agitated shareholder, the grandson of the founder. Phillip Handelmann owns a small--though no doubt growing--share of the company and has been publicly admonishing the management of the company for mismanaging the company. I do not know where this leads, but among the end games are a bid by Phillip Handelmann for the company. Of course, this is pure speculation on my part.
Other than those issues, this is simply a mispriced, hated/overlooked company that generates a ton of cash and has an unreasonably low public-market valuation.