Analyst Sees Upside to Radica Games (RADA)

David Riedel of Riedel Research Group recently published a positive note on Radica Games Limited (ticker: RADA). Excerpts:

Sound business strategy

The casual games segment is RADA’s core competency as these games are easy to learn, accessible, addictive, and fun to play. This sector of the game market has been growing over 30% per year.

Diversified target market

RADA sells its products in 35 countries, through 200 retailers in the US and the UK and around 30 distributors worldwide; it is one of the leaders of the global electronic games and toy market. RADA had the third largest market share in the electronic handheld and tabletop electronic games market in the US in 2004.

Capacity expansion

RADA’s factory in southern China has a production capacity of 800,000/week. During 2005, RADA expanded capacity by over 20-25%. This provides more flexibility and enables the company to keep up with increased sales levels, while also increasing its on-time shipping percentage and reducing the need for air freight.

Recent Results

The company recently released results for the quarter and year ended Dec 31, 2005. The company posted record full-year sales of $163 mn (up 32% from the prior year). Full-year diluted EPS was $0.54 vs. $0.18 in 2004. Excluding goodwill impairment charges in 2005 and 2004, EPS grew 133% to $0.84. Sales in the fourth quarter grew 5.1% year-over-year led by growth in electronic games offset by declines in video games accessories and manufacturing services.

Valuation

We believe the RADA’s revenues will grow at a CAGR of 16% through FY06. We estimate an intrinsic value of $11 with a P/E of 17x estimated FY06 EPS. We believe that it has a scope for further 20% upside to our target price.

Investment Concerns

Dependence on current products appeal and new product introductions

RADA’s operating margins are heavily dependent on the appeal of its existing products. With the coming in of new technologies, and the launch of new products by toy makers, existing products lose on demand and market position.

Dependence on major customers

Historically, a significant portion of RADA’s sales was concentrated with a few large retail customers. Wal-Mart, Target, Toys R Us, Kmart, Kohl’s, Argos and Best Buy are its largest retail customers, while Hasbro is the largest manufacturing customer. In FY04, around 55% of net sales were generated from its top five customers, with Wal Mart alone accounting for 25%.20% 25% 30%.

Seasonality

RADA experiences significant seasonality in its operating results and working capital requirements due to the toy sales and gift-giving seasons in the US and Europe.

Unpredictability of Video Game Accessories segment

RADA‘s VGA product line is dependent on manufacturers of video game consoles, such as Sony, Microsoft, and Nintendo.

Financials and Financial Projections

RADA has an operating history of more than two decades, during which it has successfully diversified its product line from mere casino games to electronic toys and youth electronics, with successful entry in various geographical markets.