Hastings Entertainment: Potential 5 Bagger, Deep Value Stock With A Special Situation

| About: Hastings Entertainment, (HAST)

Hastings Entertainment (NASDAQ:HAST) is a company that has been around for over forty years, and is trading at just seventeen cents on the dollar, with low debt and strong cash flows. The business originally started as a discounter with a connection to Wal Mart, and this experience gave Hastings management the drive towards becoming a low cost leadership model and wholesale distributor in their markets. While Hastings used to be largely a retailer of music, today the company has diversified substantially into new and used entertainment merchandise, electronics, coffee, clothing, e-commerce and thrift.

Many times, investors misunderstand a company's prospects simply because that business is in a tough industry. While it is true that 20% of Hastings revenues come from books, most investors don't realize that used books for $5 have growth potential, as many people switch to e readers and look to ditch their possessions on the cheap. Music is similar for Hastings, because a Vinyl sales are actually in growth mode across the country and at Hastings. Additionally, consumers can buy used cds from Hastings and download the music to their IPhones for a lower price than buying songs online, while maintaining the convenience of owning a physical disk for listening in their car. While books and music are industries in secular decline, Hastings has the potential to be the only game in town for these products and will always have the lowest prices available because of their discounter approach.

This "dollar store" concept has fueled the company's growth in years past, and most investors think Hastings is the same as Transworld or Borders, when in fact, books and music only make up 32% of Hastings' revenue. While many investors worry about Hastings' future in the movie business, this fear is unwarranted in my view, as customers find that Hastings offers the lowest prices on DVD rentals and Blu Ray purchases. Hastings is the only new and used retailer of movies, offering $.50 per day rentals, has movies before Netflix and Red Box, and could see a substantial boost to revenues as Blu Ray picks up momentum in the future. One bad quarter for rental does not make an overall trend, and over the years, Hastings has managed to avoid taking on a large amount of debt while generating a substantial amount of cash flow. Movies are the biggest category for Hastings, and I see bright things ahead for this company, because Hastings offers a better value proposition than their competition both on price and selection.

Valuation: Here is where things get really interesting for investors in the stock and why the shorts are really ignorant of the facts of the investment case: Hastings is trading at just 17% of tangible book value (tangible assets excluding goodwill minus all liabilities). If Hastings were to trade for book value again, which it has many times in the past, the stock would have to rise some 500% from current levels.

While I love new technology, and I am a fan of the iPhone, iPad, and the tablet computer, I have to find value where value exists -- asset plays. Hastings is also a retailer of technology products such as tablet computers, new and used XBox games and systems and coffee. The people that think this company is simply ignorant of technological change are incorrect. Coffee can't be downloaded. The gohastings.com website, however, is rolling out book downloads in the future, and the site already has music downloads available for low prices at gohastings.com/downloads. The website has 300K monthly unique web visitors which is quite substantial, and Hastings likely generates around 1MM in operating cash flow from the site.

Speaking of operating cash flow, Hastings generated over $20MM in operating cash flow in each of the past 5 years, rolling most of that back into the business. That said, last year the company generated $11MM in free cash flow for shareholders. In other words, the shares are insanely cheap on 2010 cash flow, and I expect cash flow from operations to actually grow, not shrink, in the future.

All in all, this stock is trading at too cheap a multiple to make any sense, and long-term value oriented investors should check out a local store and buy some shares in this solid business model with a bright long term future. Many people think this is just another Borders, but those people are simply wrong.

Disclosure: I am long HAST.

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