K-tel -- A Trick*
By Louis "Headless" Corrigan (TMF Seymor)

K-tel International (Nasdaq: KTEL)
2605 Fernbrook Lane North
Minneapolis, MN 55447
http://www.ktel.com


K-tel the Company

K-tel is best known as a direct marketer of musical compilations, featuring kitschy hits from the 1970s. On May 1st, it launched a new online music store called K-tel Express, which offers 250,000 music titles and 35,000 video titles. Recent Liquid Audio enhancements allow K-tel to feature 5,000 songs, including 3,000 Top 100 hits from its own music catalog, for instant download by consumers wanting to create their own dance mixes. The company has a marketing deal with @Home (Nasdaq: ATHM).

K-tel also markets other consumer products, though that business is in flux. Late last year it started a third-party media-buying and infomercial subsidiary that boosted revenues substantially in the first part of FY98, but proved a money-loser. That unit has now been mothballed and, in March, the firm beefed up its European direct-response marketing by acquiring U.K.-based Regal Shops.

Results for FY98 (ended June 30) showed that, while revenues rose 13% to $86 million, the company lost $2.4 million or $0.31 per share versus a largely untaxed net gain of $3.2 million or $0.43 per share in the year-ago period. Fourth quarter results were worse, with a 14% drop-off in sales to $20.8 million leading to a loss of $3.1 million or $0.40 cents a share versus an untaxed gain of a penny per share in the year-ago period.

K-tel's Stock Performance

Last spring, K-tel went from an all-but-forgotten TV marketer of dance mixes to an Internet darling. As a thousand Internet tulips bloomed, K-tel appeared to be one of the fairest of them all, blossoming to a 1200% gain in just a month. As those tulips wilted, K-tel did too, though its stock is still nearly 100% above its 52-week low.

What Wall Street is Saying...

"Internet insanity." That's about all Wall Street has said about this stock. While a couple of self-styled "analysts" of the hit-and-run variety posted upbeat scenarios to the masses via the PR wires, no widely respected firm covers K-tel.

Why the Trick?


Sometimes the best new stock to egg is the one already dripping with yolk.

1) The company has been losing money. While $0.4 million of the FY98 losses stem from one-time start-up fees for the online store and another $2.3 million come from the discontinued media-buying operation, the company has also suffered from soft sales and declining margins in its core domestic mid-line and budget-priced music lines.

2) It has limited financial resources -- with $2.7 million in cash and $4 million in long-term debt as of March 31st, prior to the fourth quarter loss.

3) To compete online, the company requires "substantial additional financial resources, development and acquisition of technology, investments in marketing, and contractual relationships with third parties," according to Chairman/CEO Philip Kives.

4) K-tel has yet to break out its online revenues, but they are likely a pittance compared to better-positioned online vendors of CDs and videos such as Amazon.com (Nasdaq: AMZN) or the soon-to-be-combined CDNow (Nasdaq: CDNW) and N2K (Nasdaq: NTKI). All of these firms have high-profile marketing deals with online services and search engines that will make it hard for K-tel to compete. Amazon, in particular, has huge financial resources. Given the cutthroat pricing online, skeptics wonder if any of these companies will ever turn a profit. So deep pockets are a prerequisite just to stay in the game.

5) Insiders took the soaring stock price as a chance to sell shares, which they continued doing even as the stock kept falling.

6) When I last delved into K-tel on May 6, I figured that the company might be worth $4.67 to $6.67 a share, after accounting for the 2-for-1 split. But that valued the brand generously at $20 million, or $2.45 a share. It now seems obvious that K-tel won't enjoy any great synergies from taking its brand online. Adding the cash as of March 31st ($2.7 million) to accounts receivable ($13 million) and subtracting total liabilities ($29 million), K-tel actually had a negative liquidation value of about $13.3 million, or substantially less than its $5 million book value at the time. And that doesn't include the fourth quarter loss.

7) The company didn't file its annual 10-K with the SEC by September 31st, as required. Late filings are never a positive sign.

8) Although the stock has already plunged from its highs, many individuals who bought into the hype are probably sitting on losses. They may be tempted to bail out of the stock by year-end to use those losses to offset capital gains.

Concluding Folly

Tricksters thinking of shorting this stock must note the risks. A well-capitalized outfit might see more in K-tel's brand than I do and pony up some outrageous price for its K-tel Express operations, or inject cash directly into K-tel. Also, general market worries could dissipate and terrific results from other online merchants might pump K-tel's stock back up a bit on general euphoria and a possible short squeeze.

The latter point, though, is probably the most serious risk. Checking the latest short interest stats, we see that 1.53 million shares have been shorted while Market Guide notes there are just 1.8 million shares in the float (shares available for active trading). Given the huge selling by insiders, the float is probably larger. Still, it's not like this disco duck is undiscovered. Thus, significant but temporary short-squeeze-related rebounds are a possibility. The huge short interest also may hold the stock above its natural market value, as shorts with big profits lock in gains by buying back the stock.

Longer term, though, I don't see any reason why K-tel shouldn't trade down into the very low single digits.

Related Links:
-- K-tel Message Board
-- Check the Most Recent Price
-- Daily Double - 4/20/98
-- Daily Trouble - 6/5/98

Next: Trick - Trump

* A Ghoul's Opinion represents the opinion of one Ghoul and in no way should be taken as the opinion of either the Motley Fool, Inc., the company in question or representative of anyone or anything else other than that specific Ghoul's thoughts.