JAKKS in the Crosshairs

 | Sep 16, 2011 | 5:00 PM EDT
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It sure has been an interesting week for Malibu, Calif.-based toy company JAKKS Pacific (JAKK), a member of my JIMS CRAB FEST portfolio for cheapskates.

On Tuesday, Oaktree Capital Management, which currently owns 4.9% of JAKKS, fired off a letter to the company's board of directors, offering to take JAKKS private at $20 per share, which represented about a 25% premium to the current share price.  The letter had some overtly activist tones that expressed disappointment in JAKKS for not previously entering into meaningful discussions with Oaktree regarding efforts to maximize shareholder value. Oaktree also threatened to take the offer directly to shareholders.

But it was also very clear in this letter that $20 per share might just be the opening salvo from Oaktree, and it is more than likely, in my opinion, that if a deal is done it will be done at a higher price.

The toy business is highly competitive and JAKKS' operating performance has been spotty at best the past few years. Revenue which topped out at about $900 million in 2008 fell to $747 million in 2010. The company has been able to generate respectable profits, but margins have been falling.  In 2007, the company bottom-lined 10.4% of revenue and last year's net profit margin was 5.7%. The latest quarter showed a 7% increase in sales and a 40% jump in net income vs. the same quarter last year, and the company beat both consensus revenue and earnings estimates. But gross margins contracted 900 basis points. Clearly, with consumers once again tightening their belts and raw materials costs rising, there may be some challenging conditions near term not only for JAKKS, but others in the industry.

Still, Oaktree sees value in JAKKS shares. A review of the balance sheet will reveal at least some of the reasons. As of the latest quarter end, JAKKS had $247 million or $9.16 per share, in cash and just $90.8 million in debt. The per-share cash figure is compelling, especially considering the current share price of $19.83. But you could make the argument, as Oaktree has, that an adjustment needs to be made to cash in order to account for share dilution, as the company debt is in the form of a convertible note which matures in 2014. That would put cash per share on a fully diluted basis at about $7.40 per share. That's still nothing to sneeze at.

Even following the recent run-up, shares still trade at just 1.94 times net current asset value. That's one of the reasons JAKKS made it into the JIMS CRAB FEST portfolio in the first place. While it's still early, I believe that a deal will get done in order to take JAKKS private. But I don't believe that $20 per share is enough to make it happen.

Oaktree has already indicated that it might increase the offer and I believe they will have to. But whether that would be $22 per share, $25, or somewhere in between remains to be seen. One thing is clear. If JAKKS is taken out, that would put an end to JIMS CRAB FEST in its current form and I'd need to find a replacement for the "J."

 Interesting possibilities abound.

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