SPECIAL SITUATION

Amid the ever-evolving investment landscape, identifying opportunities often requires digging beneath the surface, seeking out undervalued entities whose latent potential has been overlooked by the market. In the realm of small-caps, Educational Development Corporation (EDUC) stands out as a compelling case for closer examination.

Overview of EDUC

Educational Development Corporation operates within the domain of children’s literature, publishing and distributing a rich array of educational materials. It operates via two primary business units: EDC Publishing, responsible for publishing children’s books, and Usborne Books & More, which operates as a multi-level marketing organization to sell these books.

A Deeper Look into EDUC’s Challenges and Opportunities

Not long ago, EDUC faced profound adversity. Mounting fears of bankruptcy led to a steep decline in its share price. On July 14, 2023, the stock closed at a price of $1.21 per share, a drop of over 40% since May. To put this into perspective, EDUC’s book value per share at the end of May 2023 stood at a substantial $5.12. When adjusted for the fair value of property, plant, and equipment, the value per share escalates to over $7.00, signaling a stark disconnect between the intrinsic value and the prevailing market price.

The primary catalyst for this decline was the market’s perception that EDUC was on the precipice of filing for Chapter 11 bankruptcy protection. However, recently disclosed information from the company’s SEC filings and the latest quarterly report indicates a contrary outlook.

As of May 31, 2023, EDUC had an outstanding debt of $10,959,200 on its Line of Credit (LoC) with the Bank of Oklahoma, well within its $14 million credit commitment. This commitment, which is slated to fall to $13.5 million, is expected to stay afloat throughout the subsequent month.

The company’s management, particularly Mr. Craig White, expressed confidence in its ability to successfully negotiate an extension of its revolving loan maturity date with the Bank of Oklahoma. If successful, this extension will significantly mitigate the looming risk of bankruptcy.

The Market’s Response and Future Trajectory

Over the past two weeks, the market has started to align with this revised outlook. The stock price has experienced a substantial upward swing, surging 62.8% to $1.97. However, it’s crucial to note that Mr. White and CFO Dan O’Keefe are likely still in negotiation for a third amendment to the credit agreement with the Bank of Oklahoma. Should this amendment be agreed upon, there’s a potential for the stock to reach or surpass the $3.00 mark.

Risks: The Usborne Contract and Inventory Write-Downs

While the near-term prognosis for EDUC appears favorable, certain risks persist. Notably, the potential termination of the Usborne contract remains a significant concern. Although the risk of this occurring in the near term appears to have reduced considerably, it cannot be entirely ruled out.

Additionally, there is an issue regarding inventory classification. Presently, EDUC categorizes 90% of its $63.3 million (gross) of inventory as “current,” despite the company’s Cost of Goods Sold (COGS) for the latest fiscal quarter being only $5.2 million. It implies that it would take approximately 3 years to sell its entire inventory at the current run rate. Therefore, while the company could potentially write down its inventory, it is unlikely to do so given its optimistic future sales expectations.

Conclusion

Investing in EDUC presents an unconventional value proposition. While the potential risks associated with the Usborne contract and inventory write-downs warrant careful consideration, the company’s improved debt management, along with its positive operational cash flows, points towards a potential recovery. However, investors must conduct thorough due diligence, focusing on EDUC’s strategic initiatives and risk mitigation strategies before making a decision. As always, investment decisions should be guided by individual financial goals, risk tolerance, and investment horizon.

To wrap it up, it’s important to note that EDUC is indeed a small-cap stock, characterized by significant volatility and risk. Therefore, for prudent portfolio management, it should constitute only a small percentage of an investor’s portfolio. As always, diversification is key, and individual investment decisions should reflect one’s personal risk tolerance and financial objectives.