2 Views on 4Kids

Entertainment licensor 4Kids Entertainment (NYSE: KDE  ) reported another round of disappointing generally accepted accounting principles (GAAP) results Tuesday. Revenues declined 2.4%, resulting in a 10% drop in per-share diluted earnings, both numbers in comparison to the company's Q3 2003 results. This comes on the heels of last quarter's year-on-year 5.5% revenue decline and 46% cratering of earnings. Year-to-date, revenues look pretty stagnant, with the drop being just 0.7%. Profits have been another matter entirely: They declined by more than 20%.

Put it all together, and this little purveyor of Japan-o-centric children's cartoons has had quite a rough time of it this year. It should come as no surprise, therefore, that the stock is nearly 40% off its 52-week high. But hold on a second. The GAAP results explain why Wall Street doesn't like the company, but they don't tell the entire story. Let's take a second look at 4Kids, this time, from a free cash flow perspective.

4Kids neglected to provide a cash flow statement along with its earnings announcement, making it just that much more difficult for investors to get this perspective. That's a shame, because when you look at the cash flow statement included in its 10-Q (already filed with the SEC), the company actually shows a lot of promise. Comparing the first-nine-months results of 2004 to those from 2003, 4Kids has generated $10.7 million in free cash flow year to date, for a 32% increase over last year's $8.1 million.

Given the seasonal nature of companies tied to the toy business, calculating a run rate based on that $10.7 million in free cash flow is almost guaranteed to understate the company's true cash profitability. But let's run it anyway, just to see a worst-case scenario: Assuming the company's fourth quarter were as bad as the first three quarters have been, 4Kids would still generate at least $14.3 million this year, giving it the very low enterprise value-to-free cash flow ratio of 10.2.

When you consider that Q4 will probably be a bit better than that, 4Kids actually looks intriguing. To this Fool's mind, the company already incorporates characteristics of two previously successful Motley Fool Stock Advisor picks: It has a light, IP-based business model resembling Marvel's (NYSE: MVL  ) ; and its success depends to a large extent on its ability to predict and tap into "what's hot" in juvenile pop culture, a skill in which Pixar (Nasdaq: PIXR  ) excels. Combine those two characteristics with 4Kids' still-cheap valuation, and this stock deserves a place on any value investor's radar screen.

For more on 4Kids, and why it looked even cheaper a few months ago, read:

Fool contributor Rich Smith owns shares in Marvel but not in any other company mentioned in this article.

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