Will Action Performance Hit the Skids?

A growing number of short-sellers don't think the fast-growing company can keep up the pace.
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Action Performance

(ACTN)

has been on the fast track. But a growing number of short-sellers don't think the company, which makes model cars for

NASCAR

racing enthusiasts, can keep up the pace.

Buoyed by NASCAR's rising popularity, Phoenix-based Action Performance wrapped up its 1998 fiscal year ended Sept. 30 with a flourish. Acquisitions and licensing agreements helped the company's earnings grow 88% to $25.2 million, or $1.51 per share, excluding a one-time charge to settle litigation. Sales jumped 93% to $251.9 million, compared with $130.4 million for fiscal 1997.

And Action is preparing to launch a virtual shopping mall the company expects will bolster Internet sales already generated through Action's own Web site.

"We're really excited about the Internet," says Breck Wheeler, an analyst with

J.C. Bradford

. Wheeler, like the seven other analysts who follow the company, rates Action a buy. (Her firm hasn't performed any underwriting for Action Performance.) "We consider it an upside surprise."

Action on Tuesday reports its first quarter ended Dec. 31. The

First Call

consensus is 27 cents a share, compared with 22 cents a share a year earlier. For the full year, analysts expect Action to earn $2.02 per share, a 34% jump over the year-ago period.

Action's shares trade at about 36 17/32 each, near their 52-week high of 39 1/4.

Why then have short-sellers continued flocking to the stock? In the past year, they've pushed the number of shares shorted to 3.1 million, or 19% of Action's 16.6 million shares outstanding. That's up from 1 million a year earlier, according to

Rockbridge Research

, publisher of

Short ALERT

. (Short-sellers, in a bet that a stock will decline, sell borrowed shares with the intent of buying them later at a lower price.)

The biggest question Action faces is whether underlying consumer demand for its products is as strong as the company's sales indicate. Three short-sellers, along with distributors and retailers interviewed for this story, say the company has pumped up its seemingly speedy growth by "stuffing" its distribution channel -- that is, by forcing its distributors to buy more collectibles from the company than they can sell to consumers. The result will be lower future sales, as distributors work off their excess inventory, shorts say. Action says there are no inventory problems.

"Action is a real business," says one person who is short. "There are people out there buying those cars. But the company's going to run into problems and won't be able to meet growth targets."

This person estimates that a dozen distributors he contacted are carrying roughly $5 million of excess inventory combined -- or 13.6% of Action's fourth quarter collectible sales. "If you back out a significant inventory load, the stock should be worth about half" its current level, he says.

Pushing the Limits

Action Performance's aggressiveness reflects the go-for-broke attitude of Fred Wagenhals, its chairman and chief executive. Andy Gill, a former Action board member, recalls an early trip with Wagenhals to a plant in China to buy molds the company would use to cast its models. Gill thought the company should start small with an order for just three molds, while "Fred wanted to make every

car model under the sun," Gill says.

Eventually, Wagenhals' disputes with Gill and the company's three other board members grew so fierce that the board asked Wagenhals to resign soon after the IPO in April 1993. Wagenhals did step down for several months and considered suing the company. Realizing they'd lose in a proxy fight, since Wagenhals owned a controlling interest, the board members offered to sell their stakes to Wagenhals, who agreed.

"I would never deal with Fred again," Gill says. "I'm not saying that for sour grapes. It's just certain things you don't do in business."

Wagenhals calls the bunch rotten apples. "I got in bed with some bad people on my board," he says. "They thought they could run the company better than I could. That was 22 quarters ago. I've either met or beat Street earnings

estimates since then. I guess my track record speaks for itself."

Throwing a Hissy Fit

Today, Action is one of the largest marketers of collectible race cars, which it sells to 25 distributors in the U.S. and 35 internationally. In turn, the distributors reach some 11,500 retailers worldwide. The company has other distribution channels, including its 153,000-member

Racing Collectibles Club of America

and mass merchants like

Wal-Mart

(WMT) - Get Report

and

K Mart

(KM)

. But the distributor network remains a vital part of the company's business.

"We take close precautions to make sure we don't have a backup at the distributor level," says Christopher Besing, Action's chief financial officer. "We had our distributor meeting in Phoenix

two weeks ago. There was absolutely no indication of the problem. The estimates they put in for orders are significantly increased over last year."

Of the 10 distributors and retailers interviewed for this story, four supported Besing's comments. But six others told a different story.

"There was a period at the end of the third quarter when Action shipped an ungodly amount of stuff -- a lot of stuff nobody wanted clogging up the pipeline," says a distributor. "I threw an upside-down hissy fit. I cut my orders back, and they said: 'You can't do that.'"

Distributors found many retailers couldn't absorb the merchandise. Says one retailer: "At the end of September, every day there were six different shipments. I burned my bridges with a few distributors. I chose not to accept some shipments, because there was too much stuff coming in."

Some distributors said they began selling cases of stock cars to flea markets for cents on the dollar. One distributor says he's still carrying about $670,000 in excess inventory.

The product gush seems to have slowed recently. The distributor who was turned down when he tried to reduce his allotment says his shipments have since been cut in half. And that leads short-sellers, who say the company's recent sales surge was artificially inflated, to question how Action will meet its growth targets going forward.

While cars for popular drivers like

Jeff Gordon

sell out quickly, much of the inventory sitting in the pipeline could take a long time to work off, distributors and retailers say. One retailer says he still has some Buddy Baker cars from a shipment of 48 he received in 1996. He's had to mark them down so many times, he's now selling them for just $3 above cost.

Tales like that have short-sellers predicting a yellow flag ahead for Action Performance.