JAKK

[yukiii]

JAKKS Pacific (JAKK) JAKKS Pacific (JAKK)
Q1 Sales & EPS Exceed Our Estimates on Strength in CDI;
Maintaining Estimates and $23 Target Q1 Sales & EPS Exceed Our Estimates on Strength in CDI; Maintaining Estimates and $23 Target
April 27, 2007

Price (as of close 4/26/07)
$26.60

Rating
HOLD

12- Month Target Price
$23

Sean McGowan
(212) 938-9922
[email protected]


Company Description
JAKKS Pacific is one of the largest US
toy manufacturers, with an extensive 
array of brands, including WWE wrestling
toys and games, Fly Wheels vehicles,
Cabbage Patch Kids dolls, Doodle Bear
plush, Flying Colors writing instruments
and art supplies, Road Champs vehicles
and many others. Through a joint venture
with THQ, Jakks publishes WWE video
games. 
 



52-Week Range   $15.26–25.98 Total Debt  $98 million
Shares Outstanding    32.8 million Debt/Capital  14%
Insider/Institutional*    5%/96% ROE  12%
Public Float    26 million Cash & Inv/Share  $5.86
Market Capitalization   $871 million  Book Value/Share  $22.38
FYE DEC 2006A 2007E 2008E
EPS($) ACTUAL CURRENT PRIOR CURRENT PRIOR
Q1 Mar $0.09A $0.12A $0.09E $0.03E 
Q2 Jun   0.22A   0.30E      0.30E 
Q3 Sep   1.26A   1.31E      1.19E 
Q4 Dec   0.73A   0.64E      0.71E 
Year $2.31A $2.38E $2.35E $2.25E 
P/E Ratio 10.9x 11.2x  11.8x 
Change 0% 3.0%  -5.5% 

FYE DEC 2006A 2007E 2008E
Revenue ($ mil.) ACTUAL CURRENT PRIOR CURRENT PRIOR
Q1 Mar $107.8A $124.1E $120.0E $117.0E 
Q2 Jun   124.0A   140.0E      145.0E 
Q3 Sep   295.8A   281.0E      260.0E 
Q4 Dec   238.3A   219.9E   219.0E   218.0E 
Year   765.9A $765.0E $760.0E $740.0E 
Change 15.8% -0.0%  -3.3% 

Numbers may not add up due to rounding.
* Ownership may exceed 100% due to the nature of public filings.

• Q1 EPS of $0.12 vs. our estimate of $0.09 and $0.09 last year.  EPS exceeded guidance of $0.07-0.10 and
consensus of $0.08.  We believe that all of the upside came from CDI, and that on a pro-forma basis, sales and
EPS would likely have been flattish.
• CDI continues to drive top line performance.  Reported sales were $124.1 million. $4.1 million above our
estimate.  As has been the case for the past few quarters, the strength has been mainly in CDI, acquired in mid
Q1'06.  Excluding CDI revenues, sales in Q1'07 would have been essentially flat, which is an improvement over the
past few quarters.  Increases in WWE toys, TV Games and the inclusion of several new lines, notably Pokemon
offset decreases in Cabbage Patch, Fly Wheels, Doodle Bear, writing instruments and seasonal products.
• Gross margins fell, but other expenses fell more, pulling up operating margins.  COGS rose 300 bps.  Higher
royalty and amortization expenses pulled overall gross margins down 430 basis points. Direct selling expenses
were down 360 bps vs. a year ago, SGA was down 30 bps, and other depreciation and amortization was down 100
bps.  As a result, operating margins were 60 bps higher than last year and 40 bps higher than our estimate.   
• Raising 2007 revenue estimate from $760.0M to $765.0M and 2007 EPS estimate from $2.35 to $2.38.  The
increases in 2007 estimates are wholly due to the variance in Q1; all subsequent quarters remain unchanged.  Our
2008 EPS estimate remains $2.25, and we are introducing a 2009 EPS estimate of $1.95.  All figures exclude
acquisitions.
• Maintaining HOLD rating and target price of $23. Our target price is just over 10x our 2008 EPS estimate of
$2.25. More meaningfully, it represents about 13 times our estimate of EPS excluding WWE sales and JV profits,
plus a discounted value of those profits from now until the end of 2009, when the licenses expire. Because of the rift
between JAKK and WWE, we expect WWE to terminate the contract as soon as possible, mandating that profits
from the license be considered separately from ongoing profits.  The target multiple of 13 times ongoing EPS
represents a discount of 25% to 30% to our target multiples for MAT and HAS, respectively. We view this discount
as heavy but warranted, as we don't believe JAKK should receive a P/E that larger toy companies with more stable
revenue sources enjoy and given risks related to replacing hit toy revenues as well as to the ongoing WWE
T
o
y

litigation. We estimate the WWE license contributes an average of $0.50 per share to the company's annual
earnings.
• Risks to attainment of our share price target include loss of key licenses, poor sell-through of new products, and
unfavorable developments in its legal battle with WWE.

Q1 DETAILS
Total sales rose 15.1% to $124.1M, higher than our $120.0M estimate of the consensus of $118.7M.  If
you include CDI in Q1:06's sales, the increase is reduced to 3.4% (from $120.0M to $124.1M).  Excluding
CDI sales from both periods, sales would have been flat at $97 million. 
CDI.  Sales were $27M vs. $23M in Q1:06, up 17.4%.  The company's most recent acquisition continues
to surprise on the upside, making one of the more prudent acquisitions in the company's history.
Traditional toys (TV Games, Cabbage Patch, WWE, Care Bears, Speed Stax, Telestory and many
others) excluding CDI. We believe that domestic sales of traditional toys were flat at about $50 million,
although this is difficult to ascertain, since the company no longer reports US sales by category; rather it
aggregates worldwide sales by category.  Worldwide, we estimate traditional toy sales excluding CDI
were up about 4%.   
Seasonal/XPV.  Sales of seasonal and XPV were up down 3.5%, worldwide from $8.5M in Q1:06 to
$8.2M.  Domestically, we believe the division may have been closer to flat. 
Art/Writing products (mostly Pentech and Flying Colors). Worldwide sales of writing products fell
30% in the quarter, and we believe they decreased 22.0% domestically to $9.2M from $11.8M a year ago.
This line continues to deteriorate and is a shadow of its former size (e.g., US sales in Q1:03 were
$24.5M).
Pets/Other.  Sales of Pets and other, while small as a percentage of total sales, were up 82.6%, from
$2.3M in Q1:06 to $4.2M.  We believe these sales are essentially all domestic.
International.  International sales rose 17% to $16.9M from $14.5M, partly reflecting the full-quarter
contribution of CDI.
WWE JV.  JAKK's share of the video game joint venture with THQ posted a gain of $1.5M vs. a gain of
$0.8M a year ago.  As we have noted in the past, JAKK is currently in dispute with THQI over how to split
the profit from the JV.  The old agreement expired at the end of June, 2006, and the two parties have
been unable to come to a new agreement. If the arbitrators resolve the dispute in a manner unfavorable
to JAKK, the company may need to back out previously booked profit.  If the matter is resolved in JAKK's
favor, no adjustment would be needed.  Either way, it would be cash-positive event, since currently, JAKK
is not receiving cash from THQI, but would receive a slug of cash (to be determined by the terms of the
split) from the settlement.   
Gross margin contracted from 41.0% in Q1:06 to 36.7% reflecting 300 bps of COGS increase as a
percentage of sales.  Gross profit dollars were below our estimate.
The primary expense beat was Direct Selling Expense, which was down 360 bps as a percentage of
sales year-over-year to 9.5% vs.13.1% in Q1:06.
Net income was $3.2M in the fourth quarter vs. $2.3M in the year-ago period, resulting in EPS of $0.12
vs. $0.09, respectively, and compared to our estimate of $0.09. 
Accounts receivable fell in relationship to year-over-year sales.  Measured in days sales outstanding,
accounts receivable stood at 54 days at the end of the quarter, compared to 57 a year ago.  This
improvement is probably at least partly due to the fact that year earlier, JAKK did not have CDI sales for
the whole quarter, but its receivables were included in full at the end of the quarter.  DSO's at the end of
Q1 were about 51 days, for example.  Still, the improvement is notable considering the growing
receivable for the cash to be collected from THQI for the JV profits.   
Overall, JAKK's balance sheet is very strong, with $192M in cash, and debt of only $98M, all of which
comes from an in-the-money convertible debenture.  The company is in excellent condition to deploy
cash for acquisitions, share buybacks, or dividends, should it choose to.  We expect free cash flow in
2007 to be about $2.50 per share.

ESTIMATES AND TARGET
We have increased our 2007 EPS estimate to $2.38, simply incorporating the $0.03 positive variance in
Q1 and leaving future quarters essentially unchanged.  Our full-year 2007 revenue and EPS estimates
are now increased to $765M and $2.38, respectively.  Our 2008 revenue and EPS estimates are
unchanged at $740M and $2.25, respectively, and we are introducing 2009 sales and EPS estimates of
Sean McGowan (212) 938-9922  JAKKS Pacific | 3


$700 million and $1.95, respectively.  We believe that excluding acquisitions, JAKK will see revenues and
profits fall in the future.  This, we believe, has been the case for most of the company's history.  What has
also been the case for most of the company's history is that the company does make acquisitions, having
made at least 12 in its 11 year history.  We assume this will continue, but since we cannot know the target
or the timing, we have not incorporated acquisitions into our model.
We are maintaining our target price of $23, which represents 10.2x our 2008 EPS.  While this may appear
low relative to our EPS estimates, we remind investors that we foresee substantial risk for the following
reasons:   
1. Heavy dependence on a few items, especially WWE, which could be tenuous given the
uncertainty surrounding the WWE litigation as well as the dispute with THQI about how to split the
profit.   
2. In addition, the need to replace such a high portion of revenues and the fact that without
acquisitions, there has been no growth over the years argues for a discount, as well.  Clearly the
balance sheet is strong, but if the cash needs to be deployed to buy revenue, the balance sheet
could weaken over time.  Moreover, the company may seek to retain cash to meet obligations
that may arise in connection with its WWE litigation (either in settlement or as a penalty), which
could reduce the amount available for acquisitions.   
3. Finally, we do not believe it is prudent to apply any multiple to profits that derive from WWE, since
it is possible that the company may lose this source of profits soon.  The licenses expire at the
end of 2009, which would, in our view, be the latest these profits would disappear.  Alternatively,
an adverse legal decision could result in a quicker drop.   
Our valuation approach is to apply a P/E of about 13 times to the non-WWE portion of JAKK's profits.  We
estimate that between profits on its sales of WWE toys, and its average share of profit from the THQI JV,
WWE accounts for about $0.50 per share of JAKK's annual EPS.   
A year from now, we expect investors to looking forward 12 months when evaluating toy stocks, so we
believe a 12-month target should be based on earnings for the 12 months ending June, 2009.  For that
period, we expect JAKK to show EPS of $2.15, assuming no loss of WWE profits.  Subtracting the $0.50
per share from that figures yields $1.65 in non WWE EPS.  We believe a multiple of 13-14 could be
justified.  We believe a discount to the P/E's of Hasbro and Mattel is warranted, given those companies'
more stable sources of ongoing revenue, their less uncertain legal situations, and their outright ownership
of dominant brands. Those stocks are currently selling at around 18 times leading 12-month EPS, so we
believe a P/E of 13.5 times leading 12-month EPS is a heavy but warranted discount for JAKK.
If we apply a P/E of 13.5 times non-WWE EPS, and add back the $0.75 in WWE profit expected to be
achieved between now and the end of the WWE license, we arrive at our target price of $23.   

[David Randolph]

Thanks for this extensive article on JAKK yukiii, it is quite informative. This material needs to be discussed over several updates.

Today I'm going to concentrate on two issues, the analyst's estimates and the WWE litigation.

We have increased our 2007 EPS estimate to $2.38, simply incorporating the $0.03 positive variance in Q1 and leaving future quarters essentially unchanged.  Our full-year 2007 revenue and EPS estimates are now increased to $765M and $2.38, respectively.

This analyst's views are below average:



And they're below the company's internal guidance:



So, "your" analyst is on the pessimistic side, I'm more on the average, or realistic, side.

Maintaining HOLD rating and target price of $23. Our target price is just over 10x our 2008 EPS estimate of $2.25. More meaningfully, it represents about 13 times our estimate of EPS excluding WWE sales and JV profits, plus a discounted value of those profits from now until the end of 2009, when the licenses expire. Because of the rift between JAKK and WWE, we expect WWE to terminate the contract as soon as possible, mandating that profits from the license be considered separately from ongoing profits.  The target multiple of 13 times ongoing EPS represents a discount of 25% to 30% to our target multiples for MAT and HAS, respectively. We view this discount as heavy but warranted, as we don't believe JAKK should receive a P/E that larger toy companies with more stable revenue sources enjoy and given risks related to replacing hit toy revenues as well as to the ongoing WWE litigation. We estimate the WWE license contributes an average of $0.50 per share to the company's annual earnings.

The analyst is discounting that everything will go wrong for JAKK. If you do this exercise to all publicly traded companies you'll get to the conclusion that they're all expensive and unattractive.

Let's see what the company says about the WWE litigation:





It doesn't seem obvious to me that WWE will win the case. Moreover, WWE's claims are only for Japan and other Asian countries. Well, Japan and Asia accounted for just 2.75% of the company's total sales (ex-Hong Kong). If we think of just WWE related toys, we'll see that the dispute is around just 1% of sales or so. I don't think it is legitimate to expect WWE to end the contract with JAKK in 2009, just because of this small dispute. Companies can litigate and continue to do business together, if that's in their best interests, especially when the issue in question isn't all that much relevant in the bigger scheme of things.

JAKK has its problems, like most companies. But I believe it is unfair to price it at 10 times earnings, the stock is too cheap. I expect the market to take JAKK to new highs sooner rather than later.

David if P/E of 10 is such a low multiple for JAKK then why not consider stocks like VLO which have even lower P/E and also have better technicals. Agreeably its 42B market cap but there may be others with smaller cap and similar potential. I also agree that JAKK and VLO are in different sectors but the bottom line is still $$$ potential and valuation. So it may be time to put some gas in 3SoF portfolio.

Hi stocky, thanks for the suggestion, but I don't see all that much gas in VLO, since, as you say, it is already a $42 B market cap. JAKK belongs to the Toys & Games industry, which is trading at 21 times earnings. VLO belongs to the Oil & Gas Refining & Marketing industry, which is trading at 11 times earnings. So, JAKK trading at 10 times earnings would have to rise 110% to get to the industry average. VLO trading at 8 times earnings would have to rise 37.5% to get to its industry average. But VLO is also attractive, good luck stocky

I'll continue holding JAKK, come on JAKK !!!

[David Randolph]

I don't have much time today to go deeper on JAKK's, let me just say that the stock needs just one more step upward to cross above the short term resistance level. Volume has been picking up considerable, JAKK just needs to close above $24.64 to breakout.

I'll keep holding JAKK.

[David Randolph]

JAKK, you're the man!!! Still not in the "thanks" zone, but getting closer, getting closer. Nice breakout on volume above average, enough of this 10 times earnings multiple and this "there's no organic growth" talk. There's revenue and EPS growth, it doesn't matter if it has been achieved through organic growth or acquisitions, the fact is that it exists.

Come on JAKK, come on!

[David Randolph]

JAKK, you just need to rise $2 more to please me (I'll say "thanks") and to cry out loud "I'm undervalued, start buying".

The chart has turned bullish, I expect the positive short term trend to continue.

[wxmang]

Jakk is holding up very nicely

[David Randolph]

Jakk is holding up very nicely

Yes wxmang, JAKK attempted to rally early in the session but then the general market negativity took it down a bit. But it sure wants to go higher, since it is undervalued (the reasons for being undervalued is another matter, I don't think they're warranted).

I'll keep on holding JAKK.

[David Randolph]

People have this negative view about JAKK, that's why the stock is trading at 10.9 times 2006 EPS and at 10.4 2007 estimated EPS, while the toys industry trades at 25.9 times earnings:



But, over the past three quarters JAKK beat analysts estimates, and by 50% in Q1 2007:



And that has been forcing analysts to push those estimates upwards:



In terms of a PEG comparison, JAKK is much more attractive than its industry average:



Look how expected growth for the next 5 years is similar, between JAKK and its sector, and yet JAKK trades at half the earnings multiple.

All this leads me to believe that JAKK will make a move and breakout above $27 sooner rather than later. I see the company surprising on the upside due to international expansion (JAKK only sells 12% internationally).

Technically the stock has been consolidating on declining volume. Getting ready for another bull leg, after the recent technical breakout. I'll keep holding JAKK.

[David Randolph]

Nobody loves you JAKK, but I do So you keep pushing higher and breakout above $27 so I can say "thank you"!

JAKK is trading at 11 times trailing earnings and it has been growing steadily, it doesn't matter if it was through acquisitions or organic growth, because there's wasn't any dilution either. This stock was punished because management had a very optimistic guidance for 2006 and then failed to deliver. But they've learned their lesson and were extremely cautious at their 2007 guidance, so we now have the beautiful setup of a cheap company that is about to surprise on the upside.

I'll keep on holding JAKK with strong hands.

[David Randolph]

After being losing about 10% on this stock and a lot of criticism, I'm in the green with JAKK now. As I've been saying, one shouldn't care about the first 10% up or down, that's just unpredictable short term noise.

I'm not going to say "thank you JAKK" right away because the stock needs to breakout above $27 for me to do that. But it sure looks like it's coming. The stock isn't all that far away from an all time high, if you check the long term chart. A crossover of $30 would be a massive breakout, then everybody and his mother will see how undervalued this company is.

I mean, a true American, always profitable and growing company trading at 11 times earnings? Not many like JAKK in this market of stocks.

I'll keep holding JAKK.

[stocky]

Its trades like these that sets David apart from the pack. Applaud.

[berloga]

I second that, Stocky.

[yukiii]

JAKK up yesterday, article came out said it would double based on PE, Maybe David wrote it. just joking!
I would sell.......

[David Randolph]

Its trades like these that sets David apart from the pack. Applaud.

I second that, Stocky.

Thanks stocky and berloga, we'll see how JAKK's trade ends, still too early to tell. But it's better now than a couple of weeks ago

JAKK up yesterday, article came out said it would double based on PE, Maybe David wrote it. just joking!
I would sell.......

That's interesting yukiii, do you have a link for that article? Thanks.

JAKK hit the $26.81 resistance level and couldn't hold the line, too many people were holding the stock in that area, thinking "just waiting to sell at even". I don't think selling is a wise decision, because, after all, JAKK is an American company, with just 12% of sales in international markets, looking for expansion in those markets. The company forecasts $2.39 EPS for fiscal 2007 after earning $2.3 in fiscal 2006 (I believe their guidance is conservative, because they're afraid of disappointing the market, like they did throughout 2006, when they gave a very aggressive guidance and then couldn't deliver).

By the way, I notice that analysts raised expectations just a bit over the past 7 days:



They're now expecting $2.4 for 2007 and $2.49 for 2008. For Q2 2007 they're calling for $0.24 EPS, and Q2 2006 EPS was $0.22.

I'll continue holding JAKK.

[yukiii]

Quite simply, Jakks trades too cheaply compared with other toy companies such as Mattel (MAT - Cramer's Take - Stockpickr) and Hasbro (HAS - Cramer's Take - Stockpickr). The third-largest domestic toy company has some warts, including a World Wrestling Entertainment (WWE - Cramer's Take - Stockpickr) lawsuit that might cost some cash and modest earnings.

However, its 10 P/E and 5 EBITDA multiples more than discount most unfavorable legal outcomes. Otherwise, the company has done an excellent job acquiring small, niche toy businesses and growing them. Expect double-digit revenue and earnings growth this year and a much better valuation level for the shares. A 15 P/E ratio in a 19 P/E market gets the shares 50% higher.