Thursday, April 22, 1999

4Kids Entertainment, Inc.
(Nasdaq: KIDE)
Phone: 212-758-7666
Price (4/21/99): $30


Investing in 4Kids Entertainment (Nasdaq: KIDE) lately has been anything but child's play. Thanks to the surging popularity of Pokemon and World Championship Wrestling (WCW), this seemingly obscure brand-licensing company has become an overnight success.

Licensing. It's a layer in the merchandising process most folks don't consider. You have a brand. You have a company that makes products based on that brand. In the middle are licensing companies like 4Kids. As intermediaries, they negotiate deals in one of 16 different merchandising categories. While they get the slimmest of royalties for setting up the handshake, when you have a small company with an even smaller float like 4Kids bagging major deals, it adds up.


4Kids consists of four different subsidiaries, all related to children's products. The company serves as the master licensing agent for WCW, the Western hemisphere agent for Pokemon, and the non-Japanese territory for Nintendo characters like Super Mario, Zelda, and Donkey Kong -- among others.

With the "gotta catch them all" slogan, the Pokemon game is based on training pet monsters. Finding the more than a hundred creatures has made the game addictive and, to complete the game, you often need to borrow or purchase additional game cartridges.

4Kids is also a production company, putting out the Pokemon animated series that is a top draw on the WB network. By September, the Saturday morning series will be broadcast six days a week.

The company will split its shares 3-for-2 on May 3.


Income Statement
12-month sales: $14.8 million
12-month income: $2.7 million
12-month EPS: $0.80
Profit Margin: 18.2%
Market Cap: $102.0 million (on 3.4 million shares)

Balance Sheet
Cash: $9.7 million
Current Assets: $30.0 million
Current Liabilities: $19.6 million
Long-term Debt: N/A

Price-to-earnings: 37.5
Price-to-sales: 6.9


Pokemon was already a huge success in Japan. While movies and music from Japanese artists have never translated well stateside, it is hard to deny that the country is the trendsetter in the realm of video games.

Video game consoles like Nintendo 64 and Sony (NYSE: SNE) PlayStation all hail from Japan, while Western attempts at the genre, like 3DO (Nasdaq: THDO) and Atari, have failed in recent years.

As the Pokemon characters began to inhabit television sets and Nintendo Gameboys late last year, shares of 4Kids were in the same single digits as the age of its target market.

But Pokemon wasn't even the biggest contributor to 4Kids' bottom line this past year. The celebrity-studded success of WCW has powered up new alliances for the wrestling federation that finds 4Kids in the enviable position of having to turn away business. From toys to bed sheets, from trading cards to t-shirts, WCW has been everything but Stone Cold -- and the shares nothing less than red-hot.


In the fickle world of children, most brands have limited shelf lives. I'll point you to the Tamogotchi clearance bin in aisle seven if you need proof. A few years from now, it should not surprise anyone if Furby and Pokemon are only available at a garage sale near you. But let's not dismiss the near-term prospects based on the eventual demise of imported playthings. 4Kids Chairman and CEO Alfred Kahn has tasted overnight success in the past with the Cabbage Patch line of dolls and with Colecovision. He knows that having the consumer by the jugular is done with slippery hands. But while there are few long-term toy success stories beyond Barbie, Kahn has shown the ability to identify brands that kids will flock to and has cut the necessary deals.

4Kids earned $0.80 per diluted share last year. Since Pokemon was a latecomer to the 1998 holiday selling season, it should help out 4Kids quite nicely in 1999. With WCW ratings and product sales strengthening, that franchise is bound to continue to be 4Kids' strongest contributor this year.

The incremental revenues will probably mean even wider margins, since the company has a cost-efficient thin structure with limited overhead, and most of that is fixed. How high earnings will go remains a mystery, in part because there is no analyst coverage. For now.

One major factor that will come into play this year is the Star Wars prequel, The Phantom Menace, and how toy and clothing sales for the George Lucas juggernaut will eat into other competing brands. With WCW, Pokemon, and Nintendo brands all relying heavily on young boys as customers, one has to wonder how much money will be left in their pockets after Star Wars is done with its first dibs.

While WCW is more than just a winning toy line from Toy Biz (witness the WCW-themed Nitro Grill now opening in Las Vegas), the presence of the Star Wars "force" might make a difference when a kid is strolling through Toys R Us (NYSE: TOY) with a WCW Sting action figure in one hand and a Yoda in the other, and the parent tosses out the "pick one" catch phrase.

"Gotta catch them all?"

4Kids, and even Lucas, can't. Yet 4Kids has proven that it can carve out a lucrative existence even if it has to settle for a thinner slice of the prosperity pie. While the shares may correct over the next few months as stories of Star Wars merchandise stealing sales and rack space from competing merchandise fill the media channels, Pokemon's success later in the year (through the ramped-up show production and even a theatrical release) might come back to reward the long-term investor.

--Rick Aristotle Munarriz

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