FAO Schwartz: Time for Toys

10/17/2003 12:00 am EST

Focus:

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

In addition to separate growth and income portfolios, Personal Finance maintains its "Advantage Portfolio" for more risk-oriented investors seeking high-risk/high-reward opportunities. Elliott Gue notes that these are not core holdings; rather they are kickers to a more diversified long-term portfolio. Here's Gue's latest addition.

"I'm adding FAO Schwartz (FAOO NASDAQ) to our model portfolio. A little less than a year ago, toy purveyor FAO Schwartz filed for Chapter 11 bankruptcy protection. That didn't come as a big surprise to a lot of analysts; the company had been in a profit margin squeeze for years as larger competitors like Wal-Mart and Toys R Us sold toys at lower cost and stole market share.

"FAO also had another big problem--a mountain of debt totaling in excess of $130 million. As profit margins sank and banks refused to refinance that debt, it became impossible for the company to continue funding its activities. What's more, FAO's stores in high-rent areas looked like a thing of the past. They had to recoup all these large fixed costs, something that became harder to do every time competition intensified. But FAO emerged from bankruptcy last April much stronger. Some of the debt was totally wiped off the balance sheet and the company secured fresh lines of credit and a convertible stock offering to raise funds for expansion.

"And the company is working to improve pricing power. A recently inked deal with Borders will allow FAO to sell some products and to place displays in bookstores. Because bookstores get heavy foot traffic, this deal puts the company's toys in front of more consumers. What's more, FAO and its offspring Zany Brainy are still enviable brand names.
Of course, shareholders who held the stock when it went bankrupt last January ended up with less than 10 cents on the dollar. But their loss is your gain; you can buy the FAO franchise without the debt overhang. Buy FAO under 4.85, setting a stop loss at 3.50."

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