Description

Thesis:

MadCatz Interactive designs, develops, and markets a full range of accessories for video game consoles and personal gaming systems. MCZ is one of the last unrecognized investment plays based on the projected growth of PlayStation II, X-Box, Game Cube, GameBoy Advance and other video game consoles. The company has sold off non-core businesses and is now focused solely on video game accessories under the Mad Catz brand name. It continues to gain share as it is the prominent supplier of accessories to Target and has the largest shelf space of any 3rd party supplier at WMT. In-roads with other national retailers including Best Buy, Electronic Boutiques and Game Stop is a major focus of management

Why Buy:

We believe the video game industry will be one of the strongest growing segments of the economy over the next 3-4 years. Currently, this is reflected in many of the more well-known software publishers, which have stretched valuations. But Wall Street has not recognized all of the beneficiaries yet. MCZ has consistently taken market share from the largest player in the space, Interact (owned by Recoton – RCOT). This market share shift is illustrated by significant revenue growth differentials over the last 4 quarters and by shelf space in the nation's top retailers.

Valuation:

There are currently 53 mm diluted shares (assuming all warrants and options are included) and the stock is priced at $0.99. The company has $8.6 mm in short term debt, down from $19 mm a year earlier. The Enterprise Value is approximately $62 mm. Mad Catz will report its fourth quarter in May and management has expressed comfort with revenues of $80 mm (80%+ growth in Q4)and EPS of $0.03-0.04 for the full year ending March 31, 2002. Additionally, working capital and costs are being managed tightly and we expect significant cash flow and balance sheet improvement throughout FY 03. On February 7, the company also expressed comfort in with sales of $95mm, EBITDA of $12mm and EPS of $0.11 for FY '03. Using these numbers, Mad Catz is trading at 5x March '03 EBITDA and 9x March '03 EPS, very reasonable valuations. Additionally, we expect that FY 03 numbers will be raised after Q4 results are reported.

Risks:

Distribution -- MCZ has very little negotiating power with large national retailers; Competition – The industry is very price competitive. MCZ has focused on improving their product quality while at the same time reducing their product costs. Their number one competitor is Interact, whose parent company Recoton is financially unstable; Small company/execution risk – MCZ is a small company in a volatile industry and is certainly subject to above-average execution and management risks.

Catalysts:

1. Earnings: It has been 2 years since Morris Perliss was appointed CEO of Mad Catz. He has sold off its non-accessory businesses and has put into place the systems and infrastructure to allow MCZ to service the large national accounts. He has improved the quality of their product and quality of service to allow them to take significant market share from their number one competitor. Last, he has laid out a business plan to generate significant shareholder value. Now he must execute. We believe we will see tangible evidence that business is on a strong upswing when the company reports earnings in May. The company should begin to generate positive cash flow and we will see leverage on its incremental revenues as the real earnings power of the company materializes.

2. New Product: We believe the company will generate significant revenue beginning with the holiday season from its 900 mhz wireless controller that has been in development for a year and is now being sold in limited quantities at Best Buy. We do not believe there will be a competitive product in the market this year at the price points MCZ is striving to achieve.

3. Sony PS2 Memory Card: In the fourth quarter of '01, due to a supply shortage at Sony, Mad Catz lost access to its best selling product during 2001. MCZ still does not have a committment from Sony to get the chips needed for the cards and therefore they have not included in their estimates any PS2 Memory card sales. If MCZ can get the chips, this would be a large contributor to sales going forward as it accounted for $20 mm in revenues in 2001 (27% of total). Memory cards have the highest tie ratio to hardware sales and is a large percentage of accessory sales.

4. Hardware Price reductions: We anticipate that prices on hardware platforms will decline significantly over the next year, which will promote purchases of software and peripherals, with MCZ being a significant but as of yet unrecognized beneficiary.

Catalyst