Friday, July 17, 2009

Concentrate...Or Don't

In the last few months, we've looked at a couple of examples of companies that have a significant percentage of their revenues tied to one or more customers. For example, JAKKS Pacific (JAKK) receives 33% of its revenue from Walmart, which, all else equal, is more risky than a company with evenly distributed revenues. Today we see an example of a company that has been burned by its reliance on Sears.

As we've discussed previously, Escalade (ESCA), maker of gaming tables, has looked cheap across a number of metrics. But shareholders paying attention to the company's disclosures would have seen a key risk in the fact that almost 20% of the company's sales were to Sears. While an astute reader pointed out that concentrated customers with contracts can actually provide revenue certainty, there were no contracts in this case, which reduces certainty dramatically.

In 2008, Escalade and Sears could not agree on terms for products representing a significant amount of sales, despite the fact that these companies have a 30-year relationship! As a result, the company lost 12% of its sales just like that, and the remaining sales to Sears are now at high risk of being discontinued.

While Escalade may recover from this revenue shock by cutting costs and selling assets, it is not out of the woods yet. The stock has dropped by 80% in the last year, and the company is considering removing itself from the Nasdaq to save on costs!

When confronted with companies reliant on a few concentrated customers, look for contracts! If there aren't any, proceed with caution and understand the risks.

Disclosure: None

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