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On November 27, Bill Simpson wrote an analysis of the Heelys IPO (HLYS). The IPO began trading on Friday, when 6.425 million shares were priced at $21, well above the expected range of $16-18. It opened Friday morning up 44% at $30.30 (see chart below).

The text of Mr. Simpson's original writeup follows:

Heelys (HLYS)

Heelys plans on offering 7.2 million shares (assuming over-allotment is exercised) at a range of $16-$18. Insiders plan on selling 4 million of the 7.2 million shares. Bear Stearns and Wachovia are lead managing the deal, JP Morgan and CIBC co-managing. Of note Wachovia was also the lead manager in the VLCM and ZUMZ ipos, two successful ipos with a similar demographic base as HLYS. Post-offering HLYS will have 27 million shares outstanding for a market cap of $486 million on a $18 pricing. roughly 40% of ipo proceeds will go towards repaying all outstanding debt, the remainder towards expanding HLYS infrastructure, include sales, support and manufacturing.

Capital Southwest Ventures will own 34% of HLYS post-offering.

From the prospectus:
'We are a designer, marketer and distributor of innovative, action sports-inspired products under the HEELYS brand targeted to the youth market. Our primary product, HEELYS-wheeled footwear, is patented, dual-purpose footwear that incorporates a stealth, removable wheel in the heel. HEELYS-wheeled footwear allows the user to seamlessly transition from walking or running to skating by shifting weight to the heel. Users can transform HEELYS-wheeled footwear into street footwear by removing the wheel.'

The HEELYS footwear product accounts for nearly all of HLYS revenue. All manufacturing is outsourced to Asia. First product was introduced in 2000.

The slogan is a tad corny, "Freedom is a wheel in your sole." Target demographic is girls and boys ages 6-14 and those with an 'action sports' interest. 'Action Sports' equals skateboarding, snowboarding, in-line skating etc.

HEELYS are sold through a distribution network and can be purchased in sporting goods retailers, specialty footwear retailers and department stores. A sampling of locations that sell HEELYS include Dicks Sporting Goods, The Sports Authority, Modell's, Nordstrom, Journeys and Mervyn's. They are also available at various online retailers including zappos.com. Over the past 2 years sales at The Sports Authority and Journeys has each accounted for 10%-12% of all revenues.

Sales in the US account for 85% of revenues currently. HLYS estimates that HEELYS are available in over 5,000 locations currently.

HEELYS list from $50-$100 per pair.

HLYS marketing historically has focused on event driven marketing. In the past year, HLYS has made substantial increases in their television advertising budget currently airing commercials on ABC Family, Nickelodeon and The Cartoon Network.

The growth curve took awhile to get moving, but sales of HEELYS footwear have skyrocketed the past 2 years. HLYS, HEELYS brand wheeled footwear sold 697,000 pairs in 2004, 1.4 million pairs in 2005 and 3.9 million pairs in the nine-month period ended September 30, 2006. That kind of recent growth puts this deal in a similar category as CROX.

Patents
heelysMuch like with CROX, HLYS is highly susceptible to knock-off products. Part of CROX continued strength has been their success in protecting their patents over the past year. Much like CROX, HLYS depends on one unique footwear product for nearly all revenues. To protect that product HLYS has 77 patents issued or pending in more than 25 countries.

In addition to the patents, HLYS has an exclusive worldwide license to use intellectual property related to the technology used in the grind-and-roll HEELYS-wheeled footwear. While it appears HLYS has been successful in keeping competitors out of the US market, they've not fared as well in Asia. Net sales in Asia decreased from $12.1 million in 2003 to $5.4 million in 2004, primarily due to the presence of lower priced counterfeit, knockoff and infringing products in certain Asian markets.

In addition, HLYS Japanese patent was found to be invalid. The growth in US sales has eclipsed these Asian revenue losses, one will need to keep a close high going forward on HLYS ability to protect their HEELYS products in the US. Thus far HLYS has been quite successful in defending their patents and intellectual property in the US.

Financials
$1 per share in cash post offering, no debt.

Revenues from 2001-2004 were essentially flat in the $20-$25 million range. The first half of 2005 was more of the same. After that HLYS revenues went stratospheric. Their past 7 quarters of revenue beginning with the 3/05 quarter(in millions rounded): 3/05 - $5; 6/05 - $11; 9/05 - $13; 12/05 - $15; 3/06 - $14; 6/06 - $31; 9/06 - $73.

I'm not certain I've ever seen a company make a quarterly revenue leap like this. For four years HLYS was booking $5-$6 million a quarter in revenues and then they made a nice little jump for 4 quarters beginning 6/05 to $11-$15 million quarterly. That was a nice increase, however the past two quarters of $31 million and $73 million are nothing short of amazingly fast growth. Yes, accounts receivable have grown the past 2 quarters, however they've not grown out of line with the revenue growth. The only reasonable explanation appears to be that even though these HEELYS were around for 5 years, it took until the summer of 2006 for them to really catch on.

4th quarter historically has been the strongest, responsible for 30% of annual revenues.

With this growth in 2006, looking at 2004/2005 become irrelevant.

2006 - I'm going to be conservative and factor in sequentially flat quarterly revenue for 4th quarter. HLYS recognizes revenues upon shipment and revenues their past three quarters have been $14 million, $32 million and $73 million. There is a chance that HLYS shipped too much product third period, just based on the recognized revenue growth. I think conservatively HLYS does $200 million in 2006 revenues, which would be an $80 million fourth quarter.

Yes, there is a chance HLYS exceeds this by quite a bit, however the recent growth here is so powerful it does make it difficult to continue to assume similar going forward. Should note that a search on news articles brings many mentions of HEELYS being sold out in certain areas for Christmas as soon as they hit the shelf, so again there is a chance that $80 million in 4th quarter revenues is too low.

$200 million in '06 revenues would be 350% increases over 2005. 35% gross margins, strong operating margins of 24%. HLYS is really spending very little overall on GSA compared to revenues past 2 quarters. Net margins for '06 should be 16%. Earnings per share should be $1.20. On a pricing of $18, HLYS would be trading 15 X's 2006 earnings.

15 X's '06 earnings for a company that should book 350% revenue growth isn't close. I would expect HLYS to price and open much higher then $16-$18 pricing range.

Note - HEELYS are on nearly every 'worst' or 'most dangerous' toy list by consumer safety groups. One would assume sneakers with wheels would be on these lists and would also generate their fair share of injuries to the wearers.

Is HLYS a fad? Oh, most certainly. I would submit that since HEELYS popularity is dependent on the whims of those 15 and younger, HLYS is far more a fad type company then CROX. CROX is at least a footwear choice one can make over a long period of time and a number of years and pairs. HLYS look like a one-shot deal by kids that 'gotta have them now'. I would expect HLYS stock to receive similar massive short interest as CROX. The revenue growth in 2006 has been so powerful though, short and mid-term that will be the driver here.

Conclusion
I'm really not 100% sure CROX are a fad that will fade sooner then later. HLYS I am certain is a fad that will fade. Oh yes this is as much a fad stock as you'll find. At pricing range it doesn't matter if HLYS is a fad though -- currently they're hitting it out of the park, and worries of a fad type stock really wouldn't come into play until a much higher valuation then pricing range.

I would submit that any price under $30 and all the fad talk in the world doesn't matter when HLYS blows out their 4th quarter 2006, which they will. If the market gets carried away on valuing HLYS initially then yes worries of when the fad will end come into play.

The massive 2006 revenue growth makes HLYS a buy in range and nicely above. Fad or not, pricing range is too cheap for this massive recent revenue growth.

Heelys IPO, Friday December 8:

heelys chart

Source: IPO Analysis: Heelys Is a Fad, But So What?