Description

Jakks Pacific is a multi-brand toy company that designs, develops, produces and markets toys and related products. The principal products are action figures and accessories featuring licensed characters - principally from the World Wrestling Federation, Flying Colors molded plastic activity sets and clay compound play-sets and lunch boxes, Wheels division, Child Guidance infant and pre-school toys, and fashion and mini dolls and related accessories. The focus of the business is on evergreen branded products that are less subject to market fads and feature well-known brand names and simpler, lower-priced toys and accessories. The five largest customers of Jakk’s Pacific are Toys 'R Us, Wal-Mart, Kmart, Kay Bee Toys and Target, each accounted for at least 8% of net sales in 1999. The company also sells through e-commerce sites, including Toysrus.com, Amazon.com and eToys.com. Revenues from outside the U.S. account for 7.4% of sales.

The management team at Jakks Pacific is what I believe is the main strength of the company. The Chairman and Chief Executive Officer, Jack Friedman, has been with the company since co-founding Jakks Pacific in 1995. From 1989 until 1995, Mr. Friedman was Chief Executive Officer, President and a director of THQ Inc. From 1970 to 1989, Mr. Friedman was President and Chief Operating Officer of LJN Toys, Ltd., a toy and software company.

Jakks Pacific has expanded the company by buying up small toy companies and turning them into profitable businesses. The company has an excellent record of making good acquisitions. The focus is on high margin products for itself and its customers. The company is not willing to chase after the hottest licensing products as these products require significantly higher licensing costs, which lowers margins and increases risks. The majority of the toys manufactured are contracted to companies based in China. Focusing on licensing products that are popular second tier with lower licensing fees allows Jakks Pacific to provide margins to retailers that are generally 10% to 20% higher than margins of competitive firms. This strategy has enabled Jakks Pacific to increase shelf space at the expense of other toy retailers in spite of being a relatively small company.

The growth strategy of Jakks Pacific is to expand core products with strong product development initiatives, including introducing new products, modifying existing products and extending existing product lines. In addition, the company plans to continue to pursue strategic acquisitions and expand international sales. Non-U.S. sales account for less than 8% of sales.

Product growth drivers in 2001 include Harry Potter (Jakks Pacific has the US licensing rights to develop a line of crafts and activity products), Wrestle Mania 2001, Road Champs, power scooter, Pound Puppies, Charlies Angels and BMX finger bikes. Licensing from third parties also includes Car and Driver, Barbie, Rugrats, Mickey Mouse, Barney, Teletubbies, Sesame Street, Looney Tunes, and Toy Story 2. Jakks Pacific believes that licensing enables the company to use high-quality marks at a lower cost than if purchased or created independently. Most of the products are relatively simple and inexpensive toys that are less subject to general economic conditions and fads.

At the current share price under $16, Jakks Pacific is trading at 10 times trailing 12-month earnings. With estimated 5-year growth rates between 30% and 35%, approximately 19% from organic growth, the current PEG ratio is 0.33. A very attractive valuation level. Jakks Pacific also has one of the industry’s highest profitability measures with ROA of 16.2%, ROE of approximately 21%, and gross margins in the 41% range. Relative to Hasbro and Mattel, forecasted growth rate over the next 5 years for Jakks Pacific is between two and three times the rate of the two largest toy companies. Jakks Pacific also has a lower PE ratio (Jakks Pacific 11 compared to Hasbro’s 12.2 and Mattel’s 14.4). In addition, the five-year PEG ratio is significantly lower (Jakks Pacific PEG of 0.33 compared to Hasbro’s 0.9 and Mattel’s 1.4).

Jakks Pacific’s balance sheet is strong. The company has zero long-term debt with approximately $94 million in cash and marketable securities positioning the company for new acquisitions. Earnings strength is evident with the company consistently beating earnings estimates in each of the last 16 quarters with strong quarterly year over year growth. Sales levels have increased from $12 million in 1996 to current levels of over $200 million in the last four quarters.

The stock price of Jakks Pacific has dropped from just under $30 to current levels. The decline in price has been in part due to problems related to company specific issues with management and product portfolios at Hasbro and Mattel. We also believe that the market has concerns for the dependency on WWF merchandise sales. WWF merchandise has been a significant earnings driver for Jakks Pacific in past years. The company does not provide sales by product line, although Mr. Friedman recently stated that the dependency on WWF products is expected to decline to between 15% and 20% in 2001. We estimate that current WWF products account for approximately 30% of sales in 2000. When the market realizes that the problems at Hasbro and Mattel are company specific and that Jakks Pacific is more than a one-product line company, we believe that the stock price will increase to a earnings multiple more in line with future growth prospects in the 30% range.

I believe that management at Jakks Pacific really understands the toy business. Management has proven its ability to purchase small distressed toy companies and turn them into profitable businesses. The company’s focus on lower priced toys with high margins for both Jakks Pacific and toy distributors will continue to earn Jakks Pacific increased shelf space and corresponding earnings growth. We believe that the current valuation of the company is very attractive with a 5 year growth rate in the 30% range, a PEG ratio of under 0.4, zero long term debt, and a track record that continues to gain upward momentum. This has created an excellent opportunity to purchase a high growth company with strong fundamentals at a low valuation level.

Catalyst

With the Christmas season approaching and the upcoming Harry Potter product release, I believe that the attractive valuation levels of this toy company will result in a p/e lelel in line with growth rates in the 30%+ range.