NOOF -- “Da Bears” (The Hammer Comes Down)

The Bear case is simply that NOOF has no bargaining power with its distribution partners – the cable and satellite companies – and future earnings will continue to be eroded by tough negotiations with these network owners.

The hammer came down in the first fiscal quarter of 2008 (6/2007) when the company reported that total revenue fell by 21% and decline by 17% in Pay TV segment, the company’s largest and most profitable. On top of the sharp revenue decline, administrative expenses actually INCREASED so EBITDA fell by a staggering 49% and operating eps declined by 47% to $0.08 per share (eps declined slower than EBITDA due to slightly lower depreciation).

The market did not take this news lightly and the stock cratered from approximately $8.50 to $6 in the first two weeks of August.

Why the sharp drop in revenue and earnings?

The company renegotiated its contract with EchoStar and under the new terms they will be receiving less of the revenue split. While not much more about the deal other than the 3 year duration was announced, it appears that EchoStar was able to increase its share of the split by 20%-25%.

Because the company has such high operating leverage—high operating leverage means that a larger portion of each dollar of revenue drops to the bottom line—a 20% decline in revenue caused a much larger decline in operating earnings.

The following quarter (second fiscal 2007) the performance was not much better. Revenue was down 23%, EBITDA fell by 40% and eps was down 40% YoY. On a free cash flow basis, NOOF earned $2.8M from $5.6 generated the previous year.

The recent fundamental and stock performance has clearly highlighted NOOF’s Achilles heel. Despite all indications that NOOF is the premier adult entertainment content distributor in the business, the company has no pricing power with its distributors. Future above average earnings will continually be eroded by cable/satellite operators.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.