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Friday, June 5, 1998
K-tel International
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Phone: 612-559-6888
Website: http://www.k-tel.com
Price (6/4/98): $13 3/16
HOW DID IT FIND TROUBLE?
Every hit single has a flip side. Just last month, shares of record retailer K-tel International had closed in on $80 before a 2-for-1 stock split on news that the company was going to sell music online. The frothy frenzy quickly wore thin, though.
For years K-tel had lived in the shadows of Wall Street, a dated purveyor of pop's past -- a has-been, yet seemingly still a profitable direct marketer of musical nostalgia. Of course, that was before the launch of its Web venture K-tel Express. While the site, launched on May 1, still carried a few of the flagship compilations of yore, selected titles were being given away to those purchasing the more current, mainstream selections.
Between the April 9 announcement of the website's debut and the actual opening three weeks later, the shares soared, peaked, and began to fade out. With CEO Philip Kives owning more than 70% of the shares outstanding, it meant an anemic float that didn't take publicity to push the shares higher, or, now, absent that spotlight, to push the shares back down.
BUSINESS DESCRIPTION
Yes, that's right, that K-tel. Televised K-tel spots peddling hit song compilations were a staple of late night television, no doubt an abridged precursor to the infomercials of today.
Through the years, K-tel has obtained rights to 2500 hit singles from all genres. Packaging them by musical tastes, from oldies to romantic ballads, the company has grown -- especially overseas.
The launch of K-tel Express now finds the company not only selling collections from its signature compilations but also offering more than 250,000 current releases at discount prices.
FINANCIAL FACTS
Income Statement
12-month sales: $89 million
12-month income: $1.6 million
12-month EPS: $0.21
Profit Margin: 1.8%
Market Cap: $108.1 million
Balance Sheet
Cash: $2.7 million
Current Assets: $29.2 million
Current Liabilities: $24.9 million
Long-term Debt: $4 million
Ratios
Price-to-earnings: 62.8
Price-to-sales: 1.2
HOW COULD YOU HAVE SEEN IT COMING?
In April's Daily Double we pointed out how inefficient the market had been with K-tel. The company had announced plans to go online as early as February, yet the stock, like a record needle stuck in a vinyl groove, went nowhere for two months. Apparently, for every good underreaction there is a definite overreaction as well.
Once the stock got moving it was an accident waiting to happen. As the shares rose, a few small analysts like Key West Securities' Anthony Elgindy and Stock Investor Trading News' Louis Riley climbed aboard to sing the praises of K-tel. The meager float made it an easy tout. Riley correctly pointed out the short squeeze, with dumbfounded short-sellers having to cover their positions only to drive the price higher in the process, but it was a bit of a self-fulfilling prophecy. By talking up the prospects, just as Elgindy had an amazing overnight change of heart on the company (going from a pre-split $5-7 a share price target to $30-50), he was helping create a long-favored scenario where demand would outweigh the limited supply.
But ask any one-hit wonder and they will tell you that the limelight does not last forever. Although the company went on to announce exciting partnerships with the likes of RealNetworks <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RWNK)") else Response.Write("(Nasdaq: RWNK)") end if %>, @Home <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ATHM)") else Response.Write("(Nasdaq: ATHM)") end if %>, and Billboard Magazine, just like the impressive million-hit count that K-tel Express had over its first three days of operation, it was all downhill from there.
WHERE TO FROM HERE?
The reality is that selling music has always been a low-margin business. That is why brick and mortar retailers are so dependent on high-margin impulse items like audio cassettes, CD cleaners, posters, and t-shirts to help prop up returns. Not only do the "e-tail" vendors have a hard time selling add-ons, cyberselling itself is a low-margin business because the mainstay discs must be discounted to make them attractive. As Louis Corrigan wrote in last month's A Spin on K-tel, "the result of a low margin business boosting sales by starting another low margin business was -- surprise -- a bigger, really low margin business."
K-tel will also be challenged to develop its brand online. While media coverage of the stock's rise may have attracted curious visitors to K-tel Express initially, maintaining that momentum is dependent on online real estate that K-tel does not have. CDnow <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CDNW)") else Response.Write("(Nasdaq: CDNW)") end if %> and N2K <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NTKI)") else Response.Write("(Nasdaq: NTKI)") end if %> have already lined up exclusive advertising agreements with the more popular search engines and online services. How K-tel will be able to keep up with those banner ads from CDnow's namesake site and N2K's Music Boulevard should concern investors. While K-tel is hoping its international customer database will make up for its online marketing shortcomings, winning market share is clearly an uphill battle.
Also troublesome is that K-tel now has something in common with CDnow and N2K --it is losing money. Last month the company reported a loss for its fiscal third quarter on softer sales. This was before the launch of its online presence and clearly this will be a capital intensive project for the company and may take some time to turn a profit.
With the petty float, and the fact that its price-to-sales ratio is substantially more attractive than the multiples of CDnow and N2K, there is no reason why another analyst won't come back in for an easy hype job. Because of that, K-tel may very well have another tout-ridden rally or two now that all is quiet on the trading front. However, as any Foolish investor knows, these are games that speculators play and are probably best viewed from a safe distance.
Rick Aristotle Munarriz
([email protected])
Check out the Daily Trouble Message Board!
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