Description

JAKK is a leading multi-line, multi-brand toy company that designs, produces, markets and distributes children’s toys; pet toys, consumables and related products; electronic and related products; kids’ indoor and outdoor furniture; and Halloween and everyday dress-up costumes. Sales of products under trademarks or brand names licensed from others account for substantially all (80%-plus) of JAKK’s sales. Many of their agreements contain annual minimum royalty guarantees. Approximately 30%-40% of JAKK’s sales are under a license with Disney (DIS) that covers certain Disney Princess and Disney Fairies products. JAKK’s license agreements generally require it to make specified minimum royalty payments, even if it fails to sell a sufficient number of units to cover these amounts. Monsuno and Fly Wheels are examples of brands that JAKK owns.  80% of sales were in the U.S., 9% in Europe, 11% in rest of world.

Traditional Toys & Electronics segment (55% of sales)

• Action figures and accessories (Monsuno, Batman, Ultimate Fighting Champion or UFC, Total Non-Stop Action or TNA, Pokémon);
• Toy vehicles (Road Champs, Fly Wheels, MXS);
• Electronic products (SpyNet spy products, EyeClops Bionic Eye products, Laser Challenge, Plug It In & Play TV games);
• Dolls and accessories, including small dolls, large dolls, fashion dolls and baby dolls (Disney Princess, Disney Fairies, Cabbage Patch Kids, Hello Kitty, Graco and Fisher-Price plush, infant and pre-school toys); and
• Pet products, including toys, consumables and accessories (JAKKS Pets, Kong, American Classics).

Role Play, Novelty and Seasonal Toys (45% of sales)

• Food play and activity kits (Creepy Crawlers, BloPens);
• Role play, dress-up, pretend play and novelty products for boys and girls (Black & Decker, McDonald’s, Dirt Devil,Disney Princess, Disney Fairies, Dora the Explorer);
• Indoor and outdoor kids’ furniture, activity trays and tables and room décor, kiddie pools, seasonal and outdoor products (Crayola, Disney, Funnoodle); and
• Halloween and everyday costumes for all ages (Spiderman, Iron Man, Toy Story, Sesame Street, Power Rangers, Hasbro brands, Disney Princess).

DreamPlay Initiative (new, i.e., not in numbers yet)

In September 2012, JAKK entered into DreamPlay Toys, a JV with NantWorks LLC in which it owns a 50% interest. NantWorks was founded in September 2011 by Patrick Soon-Shiong, a billionaire surgeon, medical researcher and businessman ranked by Forbes as the wealthiest American in the healthcare industry and in Los Angeles. NantWorks’ mission is “to converge ultra-low power semiconductor technology, supercomputing, high performance, secure advanced networks and augmented intelligence to transform how we work, play and live.”

Pursuant to the JV’s operating agreement, JAKK paid NantWorks $8.0 million cash and issued it a warrant to purchase 1.5 million shares of JAKK common stock at a value of $7.0 million in exchange for the exclusive right to use the NantWorks recognition technology platform for toys. The JV entered into a Toy Services Agreement (TSA) with an initial term of three years expiring on October 1, 2015 and a renewal period at the option of JAKK expiring October 1, 2018, subject to the achievement of certain financial targets, to develop and produce toys utilizing recognition technologies owned by NantWorks.

Pursuant to the terms of the TSA, NantWorks is entitled to receive a preferred return based upon net sales of DreamPlay Toys product sales and third-party license fees. JAKK retains the financial risk of the JV and is responsible for day-to-day operations, including development, sales and distribution, for which it is entitled to receive any remaining profit or is responsible for any losses, and the results of operations of the JV are consolidated with JAKK’s results.

WHY IS JAKK INTERESTING?

1)      Expectations and management credibility are very low.  Current management rebuffed a $20 per share offer from Oaktree Capital in 2011 and even went as far as to hire an investment bank with an incentive fee contingent on not selling the company.  No one of the sell-side will dare stick their neck out on JAKK presently despite continued references to very significant upside under a variety of scenarios.  This negative sentiment, combined with anti-shareholder behavior and lousy fundamental performance over the past year, has reduced expectations and management credibility to incredibly low levels.

2)      JAKK would seem to have multiple catalysts in the next two quarters including: 1) possible signs of success with DreamPlay initiative; 2) signs of stabilization of core toys business; 3) robust FCF typical of Q3 and Q4 to further stabilize the balance sheet.  Q3 earnings are scheduled for October 23, 2013.  Most of JAKKS sales occur in 2H and due to the way JAKK takes and delivers on orders (FOB/China), the company has much better visibility in 2H than 1H. 

3)      If the company continues to disappoint, it would seem vulnerable to M&A.  Roughly two years Oaktree Capital Management expressed interest in buying the company for $20 per share.  Management and the board rebuffed Oaktree and instead used $80mm of its cash to repurchase shares at $20.  JAKKS is a category leaders in sub $100mm lines that Hasbro and Mattel doesn’t compete with.

4)      DreamPlay success optionality is not reflected in the stock price.  Dr. Patrick Soon-Shiong, the billionaire creator of the object recognition technology central to the Dream Play venture, has acquired nearly 20% of the common shares (at prices 50 to 100% higher), and holds warrants (albeit out of the money) that would push his position to nearly 25%.

HOW CHEAP IS JAKK’S ADJUSTED ENTERPRISE VALUE?

 Equal to ~35% of the cumulative amount paid for acquisitions between 2006-2012 (excluding earnouts) – while assigning zero value to the core business.

~2.2x EV/EBITDA based on three-year average EBITDA

 ~3.2x EV/FCF based on three-year average FCF

EV/FCF of 5x even if earnings are zero!  D&A is approximately $30mm versus capex of around $10mm (differential is just under $1.00 per share).

HOW DO WE LOSE MONEY?

Fundamentals deteriorate substantially from here and the company is forced to raise capital at dilutive levels or sell at an unattractive price (takeunder?)

ACQUISITIONS?

Catalyst