Volume 1, Number 1 December 31, 2003
Recent Events:
Four new management teams have taken over in Industry A
and the market has adopted a “wait and see” attitude. Only one of the companies Tram-K, showed a (modest) positive operating income this year. All four companies introduced products to
the Western market—two with both X and Y, and two with just Product Y. Two companies sold everything they made, and
two were left with inventories and expensive overdrafts. Two companies improved their stock prices,
and two companies improved their credit ratings. What is interesting is that none of these factors combined to make it the
same two companies that showed improvement.
And there is unmet demand in every market. Let’s try to make some sense of it all.
LzyFair showed a modest improvement ($0.74) in its stock
price. LzyFair did not adjust
its pricing and spent no money advertising Product Y in the West, but crunched
credit sales days and boosted its sales force.
At year’s end LzyFair had $25 million in cash and a modest ($6 million)
loss in operating income. Overall LzyFair’s Q/A Index is below average, but it appears that they are investing
heavily in Product X quality (?) and simply selling off the remainder of their
Product Y stock. So, we understand LzyFair’s position this way: stock goes
up (barely), because of cash generated on small revenues and tight spending;
and credit rating goes down because of
(all other things being equal) poor Q/A ratings.
MASH
provides us with an almost opposite scenario
to LzyFair. One
lesson all new management teams must learn, is that when you forecast total
sales of inventory and you can’t show a positive operating income, something is wrong with your business model. Obviously
one-time spending on R&D etc., will impact Operating Income, but generally
speaking it is a warning flag. MASH
had the industry’s biggest revenues, the highest Q/A rating overall, and simply
swamped the competition with their advertising campaign and large sales
force. However, they did not produce
enough to capitalize on the demand they created. This model is not sustainable however, hence the message from investors:
a $0.55 drop in stock price. Lenders,
however, gave a slight boost in credit rating to the critical BBB rating
necessary for bond issuance. At this
early stage in new management, borrowing power may be more important than stock
price, but the business model cannot be ignored.
4PLAY
suffered both a drop in stock price and a downgrade
in credit rating. With a below-average Q/A Rating and a $66 million overdraft,
we are not surprised. 4PLAY
introduced only Product Y to the Western market, and with the highest price (at
$109) failed to capture even 20% of the market. Notably though, 4PLAY’s second-highest price in the East was backed up
enough to get a 30% market share. 4PLAY
was the only company to run three shifts this year, though they head into next
year with the industry’s lowest capacity.
Perhaps given their inventory stash, this won’t be a bad thing. With virtually no borrowing power, the 4PLAY
management team must analyze their competition’s performance carefully and find
the balance between adjustment and overcompensation.
Tram-K was the only company to
demonstrate a working business model this year—that is, a real Operating
Income. The market rewarded this
phenomenon by nearly doubling Tram-K’s
stock price to $7.69 in spite of a $15 million overdraft. Tram-K
made a big mistake by deciding to repay $15 million of their long-term debt at
the same time that they borrowed nearly the same amount from banks at a much
higher overdraft rate. With a slightly
above average Q/A Index and a slight improvement in credit rating, Tram-K has the best position in the
industry. The new managers have this
tram running—now it’s a question of finding the accelerator and staying on the
road.