SBJ/August 29 - September 4, 2005/Marketingsponsorship

What’s next on Action’s rough road?

NASCAR merchandiser Action Performance Cos.’ recent history has mirrored this year’s performance of its top-selling driver, Dale Earnhardt Jr. Inconsistent and rocky, fresh off a stretch of great promise. But whereas Junior and his crew can make changes on a Tuesday that can have an effect on Sunday, the results of the changes being made today at Action, the longtime industry leader, won’t be seen for a while, if ever.

Action Performance Cos. flooded the market with multiple cars for dozens of drivers.
Rumors that the company will be sold have surfaced in recent months, culminating last week with reports that it had been sold to the unlikely team of International Speedway Corp. and Speedway Motorsports Inc. At press time, industry insiders said that a deal was on the table and that Action’s board was reviewing the proposal.

Fred Wagenhals, founder, chairman and CEO of Action, denied the sale and said he couldn’t “ever see those two getting together.” He added, “I’ve got 2 1/2 million reasons why I’d like to see it sell for 25 versus 10,” referring to the size of his stock holdings and Action’s current price.

Marcus Smith, executive vice president of national sales and marketing for SMI, did not return calls, and ISC refused to comment for this story.

Whether this is just another rumor of the strong gobbling up the weak, or whether this time the company will actually change hands, the rise and fall — and, Action hopes, its rise again — could be a business course study.

A small, niche outfit out of Arizona transformed itself into the industry leader for designing, marketing and distributing licensed motorsports merchandise. Its stock price skyrocketed from $2.47 in January 2001 to $46.63 barely 15 months later, and the company’s potential seemed to parallel that of NASCAR’s.

Three years later, Action is struggling to stay afloat, a victim of questionable management decisions and, arguably, simple greed. That once lucrative stock price now sits around $12, despite the company’s market share still being roughly 70 percent, according to most analysts.

The hole the company dug is so deep that despite bringing on board Herbert Baum, a known company cleanup artist, analysts and investors are not sure which Action to expect in the future: the one from 2002 that had $406 million in revenue and net income of $45 million, or the one from 2004 that had $344 million in revenue and net income of just $500,000.

Sean McGowan, an analyst for Harris Nesbitt Gerard, said recently announced recovery plans by Action could position the company for long-term success, but he wonders if it’s too little, too late.

“Even the company is preparing people for air pockets,” McGowan said, “and sometimes air pockets are fatal to flight, so we’re advising people to sit on the sidelines, expect the stock to get rocked for the next couple of quarters and we’ll see where we are when they get through it.”

Dennis McAlpine, an analyst for McAlpine Associates, is more frank.

“It’s a hold,” McAlpine said, “because if you were dumb enough not to sell it before, it’s too late now.”

Distribution debacle

In 2001 NASCAR’s popularity exploded, thanks largely to the consolidation of the sport’s television rights and the attention generated by the death of its biggest star and Action’s largest client, Dale Earnhardt. Current fans were buying anything and everything Earnhardt-related, while at the same time new fans were following the sport at a greater rate than at any other time in history.

Action stood to gain the most, and at the beginning it did. The merchandiser’s sales jumped 25.3 percent in 2001 and 25.8 percent the following year, and its stock soared (see chart).

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But that success was short-lived. Action attempted to satisfy the sudden and enormous demand by signing up virtually every available NASCAR driver and producing reams of product. Overestimating NASCAR fans’ purchasing power, Action simply had too many licenses and produced too much product for each of them, inadvertently flooding the market with excess supply.

It’s a decision that has haunted the company ever since.

“The main problem was not recognizing that the increase in sales in the industry that happened after Dale Sr. died was not sustainable,” McGowan said.

For the first 14 years of its existence, Action has distributed its product through a distributor-based model. Action makes the product and sells it to a distributor, who then sells it to a retailer for distribution to consumers.

But Action’s 15 distributors were free to order as much as they wanted, shipping to the customers whatever they wanted, McGowan said. And despite the advent of eBay and other Internet auction sites, there were no checks and balances to ensure that the distributors weren’t over-ordering what was intended to be scarce product and then selling that merchandise on the Internet themselves. That left retailers often getting the less-preferred product, according to McGowan.

Wagenhals and several distributors agreed that such a practice was happening, and that it was a problem. But they also pointed to a lack of responsibility at the retailer level as well. Brent Powell, a sales representative for Dallas-based Hamps Supply, an Action distributor, said it was common for retailers to order product from three or four distributors and only finalize the order from the one that delivered the goods first. The other orders would be canceled, Powell said, leaving the distributors with product that they had to dump elsewhere.

And dump it they did.

As distributors fell behind in payments to Action, the company gave them more product to help them out of their financial burden. A snowball effect followed, and more and more product ended up on eBay, analysts said.

Even though the company has starved the market this year in an attempt to regain control, Action product continues to pop up on eBay daily. A search last week for Action/Revell (an Action die-cast brand) returned more than 14,800 “collectible” items on eBay.

To alleviate that problem, Wagenhals said the company has halved its number of licenses from 300 in 1999 to about 150 today, and it plans to eliminate more than 60 percent of all NASCAR die-cast models. Equally important, on Oct. 1 of this year, Action’s first day of fiscal 2006, the company is making the switch from its distributor-based model to a direct-to-retail model, a move that it hopes will eliminate the inventory problems that have handicapped the company to this point.

“When we worked in the distributor model, [the distributors] could have said 10,000 cars and we’d have built them,” Wagenhals said with a hint of regret. “It’s going to be a lot easier having 2,500 dealers tell us exactly what they want, what number they want. We are going to build what we’ve got orders for.”

One longtime distributor, who spoke on condition of anonymity, said the distribution problems were far more complicated, pointing to the company’s lack of a contingency plan for excess product.

“No matter what it is, if it doesn’t sell through, we should have a program where we collect all the stuff that doesn’t sell and return it and either give it away to charity or damage it or throw it away,” he said. “You know, the things that most companies do to protect the brand.”

Wagenhals agreed that a policy should have been in place but said that the company has now started to limit its product and, come Oct. 1, all inventory should be new, fresh and more limited.

In addition to not having a sufficient system to protect the brand, several distributors said Action was not selective enough about who distributed its product and how and when the product was distributed.

“Some of the distributors that bought the product did not have the capital to hang on to it, to stock it, to inventory it and to sell it,” one distributor said. “What they would do is the stuff would come in and they’d take their quick dollar return and whatever was left over, they’d dump. What Action should have done is said, ‘If you can’t take product and hold on to it and have the working capital involved to be in business, then you shouldn’t be a distributor.’”

Wagenhals said he had 52 distributors when the company was started, in 1992, so he didn’t think 15 was excessive. In hindsight, he said, eliminating troubled distributors would have made sense, but each one had its problems, a realization that led to the decision to change the company’s model.

“If you started checking who was dumping product, you’d probably find that all 15 had some fault,” Wagenhals said.

The direct-to-retail system should improve the situation, but McGowan and others wonder if it is too late.

“This move to get more control over the direct distribution of their product is the right move; it’s just overdue,” McGowan said. “It would have been better to do this from a position of strength two years ago rather than do it now when the balance sheet isn’t as strong and business isn’t growing.”

Diversification

As Action gained momentum at the start of the century through increased sales and impressive income levels, the company looked outside its core business in an attempt to diversify its operations.

Many of those decisions contributed to its downfall.

“As I look back now, I would say it did,” Wagenhals said. “I think every time we get back to paying attention to our core business, we do a lot better.”

Through acquisitions, Action steered away from die-cast cars into apparel and other markets.
In 2001, Action acquired the Winner’s Circle brand from Hasbro and the Castaway collectible business, a brand that marketed die-cast boats. In 2002, the company acquired Trevco Trading Corp., a seasonal gift products company, McArthur Towel and the Jeff Hamilton apparel business. It also entered into a joint venture with TMP International, the producer of McFarlane Toys.

According to Action’s most recent quarterly report, it has divested itself of its McArthur business and expects to complete the sale in the fourth quarter of this year. The NASCAR merchandiser also has decided to discontinue the Hamilton apparel business and the Castaway collectible brand, noting that each business had declining sales for the prior three quarters.

Baum, the company’s new executive chairman, told investors during an earnings conference call earlier this month that Action will become what it was founded to be, a NASCAR company.

“We are not a toy company, we are not a collectibles company, we are not an apparel company,” he said. “What we are is a NASCAR company.”

One distributor, who did not want to be identified for this story, said he and other distributors tried to warn the company several times that its focus should be NASCAR.

“I can remember when Dave Martin [former chief financial officer] came onto the scene [in 2000],” the distributor said. “We were actually at a distributor meeting and I raised my hand and I said, ‘Promise me you won’t let Fred go out and buy any more companies.’ And he unequivocally said, ‘That won’t happen under my ruling.’ And then right after that they ended up buying all that s---.”

Wagenhals admitted to learning a hard lesson.

“I might as well accept that fact,” he said. “Fish where the fish are, and the fish are in NASCAR.”

Cutting costs

Along with narrowing its focus, the road to recovery for Action includes cutting costs. In its most recent quarterly report, the company outlined the following plans to control expenditures:

Reduce the work force at its Tempe, Ariz., headquarters by about 20 percent — or by as many as 100 jobs or more.

Sell its 12.5 percent ownership in a corporate aircraft, with proceeds of about $800,000 expected.

Give no dividend for the quarter ended June 30. It has no plans for paying dividends “for the foreseeable future.”

Close the Los Angeles location of Funline, which makes non-traditional die-casts such as muscle cars and NHRA dragsters, and consolidate its administrative functions in Phoenix and Atlanta. Action hopes to complete this by January, producing annual savings of between $2.5 million and $3 million.

Open a sourcing office in mainland China to reduce the cost of production.

Establish a policy for capital expenditures to limit future annual spending to a level below annual depreciation.

But in addition to cutting costs, the company also has to focus on revenue, the other element in the profitability formula.

That part of the equation does look brighter, as Action has reached an agreement in principle with Dale Earnhardt Inc., the racing home of cash cow Earnhardt Jr., to extend its license through the end of 2006. The Earnhardt Jr. contract alone, which the company says represents 26 percent of its revenue, should allow Action to survive at least another year. Action also has contracts with 18 other NASCAR drivers, including Jeff Gordon, Jimmie Johnson and Tony Stewart, as well as NHRA legend John Force.

But it remains to be seen whether Baum can orchestrate a mass cleanup within the company similar to the one he performed while he was president and CEO for the Dial Corp. Wagenhals recognizes the differences between what Baum did at Dial and what he’s expected to do at Action.

“Selling soap doesn’t have anything to do with selling T-shirts and cars,” he said. “You need a bar of soap. You don’t need a $25 T-shirt, and you don’t need a $60 car.”

McAlpine said overhauling the distribution system and initiating change throughout the company are solid steps, but he wonders if the company hasn’t “permanently damaged the market.”

“Maybe people have just gotten tired of trying to collect stuff that they know there’s going to be a huge amount of,” he said. “And they’ve just given up because they find out there’s no value to it.”

McGowan echoed those doubts.

“The simple reality is, it’s hard to build a business … that at its core is trying to sell a lot of something whose intrinsic value is its scarcity,” he said. “How do I sell a lot more of something that the customer doesn’t want to see a lot more of?”

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