San Diego The world's biggest maker of baseball gloves can't make any errors. The company, K2 Inc., moved to Carlsbad from Santa Monica last year. It has more than a billion dollars in annual sales of sporting goods -- baseball and softball equipment, fishing gear, skis and snowboards, and paintball equipment. Right now, things look good, but this company has been piling up debt so fast to make acquisitions that it can't afford to have any buyouts backfire.
Most companies that issue debt and dole out their own stock to buy other companies in a hurry run into problems -- often fatal ones. That's the lesson of the conglomerate era of the 1960s and the takeover movement of the 1980s. Companies in San Diego County -- including Carlsbad -- have learned that lesson.
But right now, K2 is a Wall Street darling. Sales zoomed 99 percent, and profits soared 293 percent in its most recent quarter, ended September 30. On the other hand, the company's debt more than doubled, from $148 million a year ago to $383 million. During that period, the company also doled out 10.1 million shares to make five acquisitions. In just a year, it has purchased nine companies.
Alan House, securities analyst for Wall Street's Value Line, says that ski and snowboard sales are hot right now, while baseball and softball should do well in the spring. The company's earnings growth should be strong through 2005, he says.
Wall Street loves acquirers that gobble up other companies quickly because it gets fat on investment banking and finders' fees, among many things. When a company launches an acquisition spree, it always looks good. It's only after the acquirer has owned a company for a while that it discovers it bought a stinker. "Wall Street loves to finance these types of companies and talk them up until they falter," says securities analyst David Allen of Palomar Equity Research of North County. Sporting-goods equipment is not a growing industry. Thus, "There is no room for error." If there are dogs among the purchased companies, the debt burden could become onerous. Also, those shares that were doled out to buy other companies could dilute the ownership of current shareholders.
K2 admits as much in its latest annual report to the Securities and Exchange Commission. "We have incurred substantial indebtedness," says the company. Today, this debt includes $100 million of bonds that are convertible into common stock and $200 million of notes that are rated BB, or junk-bond status. The company admits in the filing that its substantial debt could harm its ability to tap lenders for more money, make it harder to compete with companies having less debt, and hurt its chances to expand the business and make capital expenditures.
Company spokesman Andrew Greenebaum notes that in the most recent quarter, K2 had organic growth (growth that does not include acquisitions) of 12 percent. That's excellent. It should be able to keep organic growth going at a mid-single-digit percentage rate in the future, as it expands marketing opportunities and product development for the many brands that it buys, he says. But overall, those companies are run autonomously. Right now, the acquired companies are contributing immediately to earnings. If that keeps up, the debt won't be a problem, says Greenebaum.
However, such performance would go against the company's sometimes rocky history. It first went public in 1959 as a swimming-pool maker. In 1980, it acquired Shakespeare, a maker of fishing equipment. In 1985, it bought K2, a maker of skis, skates, and snowboard equipment. During these years, it also bought some industrial concerns that it later shed. In 1996, the company sold the swimming-pool business and changed its name to K2. But bad times hit. In 2001, it closed plants in Washington, Minnesota, and Alabama and moved the businesses to low-wage countries offshore. Now, 80 percent of its manufacturing is done abroad. (And therefore it's not surprising that Wal-Mart accounts for 15 percent of its sales.)
K2 lost money in 2001, and for a while it was out of compliance with its bank-loan covenants. That brought plant closures and downsizings. "Growth was slow for about ten years until the company started making acquisitions," says Allen.
In October of 2002, the company named Richard Heckmann as chief executive officer. He is a veteran of several industries and has served on the board of such companies as Waste Management and Station Casinos. He launched an acquisition binge concentrating on sports equipment.
Rawlings, the largest maker of baseball equipment, came onboard in March of 2003. In September of that year, K2 bought Worth, a maker of softball gear. Two months later, it completed a deal for Brass Eagle, a maker of paintball products. Early this year it snapped up Fotoball, a San Diego maker of team sports souvenirs and memorabilia. Fotoball had made money in 2002 but had been losing money for nine months in 2003 before the buyout. As this year progressed, K2 added several companies, including makers of skis, ski bindings, and outdoor apparel and equipment.
Now, marine and outdoor-sports equipment are 45 percent of sales; action sports gear such as skis, snowboards, skateboards, bicycles, and paintball equipment are 39 percent; and athletic equipment for baseball, softball, and other team sports are 16 percent.
Sitting on the board are two jocks of note: Lou Holtz, retiring football coach at the University of South Carolina, and Dan Quayle, former vice president of the United States, who is said to be a heckuva golfer.
K2 has more than 3500 employees, but only 30 are in the Carlsbad headquarters. Many of those are the ones who reconnoiter possible acquisitions. But, admits K2 in its last annual report, another risk of the feverish acquisition pace is "substantial diversion of management's attention from day-to-day operations." Stockholders and noteholders could get burned, K2 admits.
But these new enterprises have to be integrated into K2 to get efficient, says Allen. "There's always a risk when you are integrating a lot of acquisitions. Something doesn't work -- a risk comes out of the blue."
Plenty of San Diego companies found that out. Wickes Companies went bankrupt in the 1980s because it couldn't service the debt it had taken on to buy a Minnesota diversified retailer. Debt also undid Intermark, a highly diversified conglomerate, which went bankrupt in 1992. Sunrise Medical moved to Carlsbad in 1994 and shortly discovered internal cooking of the books. In 2000, the company was sold for a low price. Rapid acquirers such as U.S. Financial, Westgate California, and Peregrine Systems failed because of fraud.
As it pursues its rapid acquisition strategy, K2 must not take its eyes off the ball -- particularly an oncoming paintball.