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Tuesday, June 16, 1998
Broderbund Software, Inc.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BROD)") else Response.Write("(Nasdaq: BROD)") end if %>
Phone: 415-382-4400
Website: http://www.broderbund.com
Price (6/15/98): $17 3/16
HOW DID IT FIND TROUBLE?
You have entered a world where clues pile up like strange journal fragments. You find the terrain surreal yet familiar. With each pulled lever, each deciphered message, your journey leaves you still just one step from tragedy. Suddenly, the mist clears and you find you've been... riven!
Broderbund investors are wishing they've spent more time getting to the next level of Myst and less money buying the company's stock. From a high near $79 hit during the fall of 1995, the stock has plunged.
After falling to $17 3/4 in April '97 following intense price pressures in the interactive software market, Broderbund shares rallied to $37 3/4 last autumn. The imminent release of Riven, the long-awaited sequel to the blockbuster mystery game Myst, seemed a good excuse for a turnaround.
While Riven helped the firm deliver an estimate-beating November quarter and an on-target February quarter, investors have begun looking past these worlds of mystery. They apparently see a software vendor with a good but slow-growing stable of titles in a market where marketing muscle has never been more important and price competition remains stiff.
It didn't help that Cyan's Rand and Robyn Miller, the creative geniuses behind Myst and Riven, have dissolved their partnership, making it even more unlikely that this popular Broderbund franchise has a future. Cyan is a company run by the Millers; Broderbund has an exclusive deal with Cyan to distribute Myst/Riven.
BUSINESS DESCRIPTION
Founded in 1980, Broderbund is a leading developer of interactive software for personal productivity (40% of second quarter sales), entertainment (41%), and education (12%). It also distributes third party software titles, such as Encyclopedia Britannica 98.
Broderbund's top titles include Myst, the all-time best-selling entertainment CD title, with over 3.5 million copies sold since October '93, and its sequel Riven. The company also markets leading brands in the personal productivity space (The Print Shop, 3D Home, Family Tree Maker) and kids educational market (Carmen Sandiego, Kid Pix, and the Living Books series, which includes interactive titles based on Dr. Seuss classics and other featuring the famous aardvark Arthur and his gal pal, sister D.W.).
In the first quarter of FY97, Broderbund acquired from Random House the 50% of Living Books it didn't already own. Last August, it acquired Parsons, a product development group with an experienced direct-to-consumer marketing organization, from Intuit.
The firm's customer database includes a third of all Americans who own multimedia PCs. Competitors include Electronic Arts, The Learning Company, Cendant's Sierra On-Line, Disney Interactive, GT Interactive, and Microsoft. Insiders own 11% of the stock.
FINANCIAL FACTS
Income Statement*
12-month sales: $262.8 million
12-month income: $12.2 million
12-month EPS: $0.57
Profit Margin: 4.6%
Capitalization: $365.2 million
(*Excludes acquisition expenses and other one-time charges.)
Balance Sheet
Cash: $137.1 million
Current Assets: $184.7 million
Current Liabilities: $63.9 million
Long-term Debt: none
Ratios
Price-to-earnings: 30.2
Price-to-sales: 1.4
HOW COULD YOU HAVE SEEN IT COMING?
Broderbund looked ill a year ago. In March of '97, the company warned it would produce earnings of just $0.15 a share in the second quarter versus analyst estimates of $0.31 a share. Post-holiday volume rose 30%, but prices had plummeted, cutting revenue to just $44.3 million from $48 million. June brought break-even results that missed estimates by a nickel per share. The fourth quarter, ended August 31, was just as bad: a $0.11 a share loss, nine cents worse than projected.
Last summer, billionaire Paul Allen's Vulcan Ventures sold off all of its 1.1 million shares. Even as the stock rallied on expectations of Riven's launch, the company brought in a new CFO (J. Mark Hattendorf, formerly CFO at rival Acclaim Entertainment). Then this past January, longtime COO Bill McDonagh departed. Changes in the executive suite and a vote of no confidence by a sophisticated investor are pretty good signs that a turnaround may get stuck on a cul-de-sac.
WHERE TO FROM HERE?
As of early March, Riven had shipped one million units, sparking new interest in Myst and boosting entertainment sales by 402% in the second quarter and 348% for the first six months of FY98. Add in revenues from Parsons and Living Books, and first half sales soared to $178 million from $106 million a year ago.
Yet entertainment sales carry lower gross margins, partly due to royalty payments to the Millers. So overall gross margins sank to 53% in the second quarter from 63% last year. What's worse, the fundamentals of the whole edutainment and productivity software market have improved only modestly. Price competition, customer rebates, and higher marketing expenses to gain shelf space, especially in the entertainment category, have become the norm.
While Broderbund expects gross margins to return to the low 60% range by year-end, it's also looking to slash annual operating expenses by $5 million. It recently laid off about 6% of its workforce and plans to record a $2 million charge in the third quarter. Although it has launched a direct sales initiative and tried to boost sales of Internet games, neither project has attained critical mass yet.
Broderbund's troubles come at a time when leading rival The Learning Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TLC)") else Response.Write("(NYSE: TLC)") end if %> has been shedding debt for equity, making more acquisitions, and leveraging its superior distribution system. Its stock has staged a major recovery as a result. While Broderbund has been a rumored takeover target before (last year about this time), there's a renewed sense that its terrific brand and evergreen franchises could be leveraged by a firm with stronger distribution.
The latest rumor, started at the Electronic Entertainment Expo in Atlanta in late May, has Hasbro <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HAS)") else Response.Write("(NYSE: HAS)") end if %>, the world's second largest toy manufacturer, as a suitor. Hasbro Interactive had sales of $75 million last year and expects $100 million this year. Trade mag Computer Retail Week (CRW) reported the rumor June 2, indicating that Hasbro Interactive wants to extend Hasbro's toys and games into software while expanding its brand beyond family and children's titles. Broderbund CEO Joe Durrett supposedly held talks with Hasbro this spring.
On June 15, Broderbund shares dropped to $17 3/16 after the company announced that it expects to miss analysts' estimates of $0.01 per share for the third fiscal quarter ended May 31 due to customer rebates and higher product returns. The company now expects a loss of $0.12 to $0.15 per share.
With analysts currently expecting EPS of $0.89 for FY98 ending in August (likely to be reduced) and $1.04 for FY99, Broderbund could still prove a bargain. Backing out its $6.45 per share in cash, this first tier edutainment player trades at just 10 times those FY99 earnings.
If you're shopping for Arthur's birthday party, Broderbund might make a nice gift.
-- Louis Corrigan
([email protected])
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