Value Pick: 4kids Entertainment (KDE: NYSE)

It’s hardly a household name, but 4kids Entertainment is cheap. Not cheap using the typical market yardstick of price relative to earnings (P/E). To the contrary, the company, responsible for the Pokemon and Yu-Gi-Oh! TV hits on the Fox Network, has seen its revenues and earnings fade recently. What the market is missing and what Pat Naccarato, portfolio manager at AIC Ltd., has picked up on, is that the stock is trading close to liquidation value, a large part of which is comprised of cash.

In its salad days, 4kids Entertainment was a cash machine thanks to its licenses on former hit animation programming for the youth market which include Pokemon, Teenage Mutant Ninja Turtles and Yu-Gi-Oh! Hit television programs translated to million of dollars in revenues from merchandise sales including toys, trading cards etc.

Hits fade, however, and 4kids Entertainment has yet to follow up with another blockbuster show. The company has also started to produce its own titles rather than license foreign titles which were imports from Japan where some of the best and most popular animation has emerged from in recent years.

Its first, in-house production, Viva Piñata, was an “early success” says Naccarato. It was also released as a video game for the Xbox 360 console in a joint venture with Microsoft. Still despite the success with Viva Piñata, the company posted a loss in the most recent quarter and suffered a 31 percent decline in net revenues.

4kids is facing negative free cash flow because revenues are down to be sure. But things appear worse than they really are because it is plowing money into production where costs are rising. The change in its business model to producing its own original titles rather than license and adapt foreign titles, is resulting in increased capitalized film and television costs.

So where is the opportunity you may ask? Firstly, all the negatives appear baked into the share price, and then some. What investors seems to be missing is the pile of cash on the balance sheet, says Naccarato who regularly screens for companies that trade cheaply relative to assets. 4kids popped up on his radar last year after its share price was decimated by investors who reacted to the weak operating results.

“When the share price was high, the cash relative to the stock price at $80 was relatively small” says Naccarato, “It’s not like they won a windfall one day and the cash just showed up, but now it’s worth two thirds of the company.” The share price recently hit a low of US$11.24. Cash and investments on the balance sheet in the most recent quarter were a cool US$93m representing
More than half of the company’s total market capitalization of US$148m.
Its net asset value at roughly $150m suggests that investors are getting the business for free. The Yu-Gi-Oh! and Ninja Turtles Licenses aren’t worth what they used to be, but they still brought in more than US$26m in 2006.

When you factor in the value of the company’s current licenses, Naccarato figures he is getting 4kids near liquidation value. “The company has no big hits and the market cannot see a big hit in the future,” says Naccarato. “As a long term investors you can buy the opportunity to own another hit.”

That hit may be right around the corner. 4kids recently launched Chaotic, a new television production and trading game with its partially owned trading card company and website. “4kids has historically been involved in 2 of the 3 most successful trading card games ever sold,” says Naccarato. “Chaotic brings their management experience in bringing this new technology driven trading card game to market shortly, and investors are basically getting this potential blockbuster hit for free.”

“As a long term investors you can buy the opportunity to own another hit,” says Naccarato. The market’s view is that 4kids Entertainment is weak and losing money. His view focuses on a company that is trading near liquidation value and the opportunity to get a free ride with a management team that has a track record of success.