First of all, I think that senior leadership has performed excellently to achieve what they have so far. I started shorting SKUL, as soon as practicable after the IPO and was dismayed to find that so many others had shorted SKUL, as well. I needed to diversify my short positions in Sony and Panasonic, which are facing multi-year issues. If you delve into the Japanese electronics industry (and such events that lead to the creation of Elpida) you’ll know what I mean.
The summary version of my short thesis, is as follows:
- The IPO was priced too high. The lead managers of the IPO were forced to use the HTC/Beats JV as the closest valuation benchmark (referred to as the best “Comp,” in Wall Street jargon), however, if they has used Comps in the electronics industry, it would have been priced closer to $10 - $12, in my opinion. This thesis was confirmed upon the termination of Beats relationship with Monster, in preference of HTC, which proved that the consideration implied in the formation of the HTC/Beats JV was based on cost/business synergies rather than standalone business value.
- SKUL’s margins are too high relative to other electronics manufacturers. Margins are far lower for other electronics manufacturers than SKUL and SKUL’s margins are bound to normalize to typical margins. Many argue that SKUL’s margins are comparable to LULU and ZAGG, but those companies have IP that other companies cannot replicate without infringing on those companies IP. Headphones have been around for a while and SKUL's business technology is not defensible.
- SKUL’s brand is limited to the western markets. Asians prefer the likes of Hello Kitty to macabre. This is why first person death and killing console games don’t have much traction in Asia. Given that SKUL has already penetrated NA and European markets, growth rates for SKUL has to decline.
- Acquisition of Kungsbacka 57 distorted the growth rates for SKUL. Every company I know tries to beef up operating profits when they are trying to sell. Kungsbacka 57 maximized its selling efforts to achieve the highest price and now their sales channel is stuffed. That’s why part of the reason why SKUL’s inventories and receivables jumped this quarter.
Anytime you find a company with declining growth rates and margins, you should short it. There are many other reasons to be skeptical (distributed shareholder base, sketchy venture backing, signs of mgmt. hegemony, etc) and if I were to expand this post would be really long. Notice, however, that I never considered whether SKUL was a “FAD” as a reason to short it.
Any criticism to my thesis is welcomed.
Part 1 of 2
Just got back from a wonderful trip out West, Grand Canyon, Taos, Pueblo, Mesa Verde and more. Absolutely stunning scenery and history. Anyway I'm in catch-up mode so forgive me if you have read these analyst comments after earnings CC, before. BTW I had my last limit order filled at 12.84 while out West so it's time to get Skully rolling again.
Craig Hallum analyst Mike Malouf, who has a "Buy" rating and $24 price target on the stock, wrote: "Skullcandy reported another better-than-expected quarter, which continues to demonstrate the increasing strength of the brand. Based on our channel checks, industry contacts and management commentary, we feel comfortable maintaining our slightly-above-consensus estimates.
He added: "One of the fall-outs of higher ASPs is the impact it has on Gross Margins. While the Gross Profit dollars are much higher, the higher ASP products carry a lower unit level Gross Margin due to higher manufacturing and packaging costs. We will take this trade-off any day for two reasons. First, the boost in gross profit dollars ends up leveraging overall costs, causing operating margins to rise. Second, and more importantly, this shift does not happen if the brand is not gaining presence in the marketplace.
"For example, kids are unlikely to spend $70-$250 on a pair of headphones that don't express an attitude or project an image. The fact that Skullcandy's source of upside came from higher-priced, over-the-ear products can only be interpreted as a clear, continued assent of their brand."
Piper Jaffrey analyst Jeffrey Klinefelter said higher ASPs were a sign of brand equity, adding: "Skullcandy continues to make necessary investments in branding and merchandising to appropriately position the brand in the highly competitive headphone industry." He's looking for double-digit ASP growth for the remainder of the year. The analyst has an "overweight" rating and $26 target on the stock.
Keybanc analyst Edward Yruma wrote: "We characterize the earnings quality in the quarter as OK – the absolute earnings number was fine, but of course the use of the off-price channel to clear $2 million of inventory at low margins does give us some pause. Interestingly, the key risk factor in the quarter – the switch in packaging, seems to have gone well. As with other companies, protecting price integrity remains a key focus; the company's decision to dramatically reduce the number of online resellers/distributors in an effort to better control its distribution and pricing integrity should bode well for margin over the middle and long term." He kept his "buy" rating and $21 target.
Davidson analyst Andrew Burns called the top-line momentum "inspiring," adding, "Overall, we believe Skullcandy made progress improving inventory quality, successfully started an extensive new product and pacing roll out, and once again validated its revenue growth merits."
Merrill Lynch analyst Robert Ohme raised his EPS estimates and kept his "buy" rating and $22 price target, stating he expects revenue "upside driven by premium price point products."
Raymond James' Dan Wewer wrote: "Skullcandy's stock price could be under some pressure as management is lowering its GM% guidance, which may reinforce concerns that almost every supplier/retailer in the CE channel is facing margin pressure. However, the most important investment theme supporting our Strong Buy rating for Skullcandy is the success of the brand driving rapid sales growth. Skullcandy delivered the goods in 1Q12…"
Northland analyst Mike Latimore wrote: "All regions were strong, large retailers replenished shelves quickly after the holidays, and SKUL had success with its new headphones (a key part of its growth strategy)."
Finally, Jefferies' Randal Konik added: "With sales up ~50%, a robust product portfolio and strong following of the action sports consumer, we see SKUL as having plenty of growth and legs on an LT basis in both domestic and international markets. While elevated NT investments are offsetting some earning upside, this should begin to ease in 2H and provide nice flow-through in '13. Reiterate Buy.
He continued: "It's Simple, Strong Revenue Growth Shows This Is A Brand. What we like here is that SKUL plays in a growing category with secular tailwinds. The Skullcandy brand is recognizable, differentiated and authentic as it targets the action sports niche. We see visible revenue growth streams from expanding global distribution for the brand and new product launches from a robust product pipeline."
This is from The Bull Market Report:
BMR Take: Unfortunately, the market sometimes seemingly reacts to earnings reports in mysterious ways that can defy explanation. In our view, and apparently in the view of nearly every analyst covering the stock, Skullcandy reported a strong quarterly earnings report, but the stock, despite carrying a low valuation, got beaten-up.
Conversely, a richly valued stock like online jeweler Blue Nile (NILE, $31.19, Spy) reported a pretty dismal report and issued poor Q2 guidance, and the stock is zooming higher today because of a small top-line beat (EPS missed badly). Remember, Skullcandy posted a huge top-line beat and also topped the EPS consensus.
As the old adage goes, though, in the near term the stock market is often a popularity contest, but over the long term it tends to be a weighing machine. If Skullcandy can continue to briskly grow sales and demonstrate its brand power, then the stock will climb much higher from here. The short argument looks to be almost solely based on the thesis that headphones can't have brand equity and thus the growth is completely fad based. We disagree and think the higher ASPs, as argued by the Craig Hallum and Piper Jaffray analysts, help support the view that Skullcandy has become a power niche brand, especially among teenage and 20-something males.
We continue to rate the stock a "Buy" with a $20 target and still believe at some point the shorts will get squeezed in the stock.
response to Dalton
- skulls margins are inline with other audio headphone manufacturers. I have done indepth analysis in this area, even spoken to the ODM for Apple, Sony & Philips.
- skulls brand is not limited to western markets, whilst it doesn't have much of a presence in Asia & Europe there is no cultural or religious aspect which would prevent the mass adoption of this brand in those regions. As long as they continue to focus on building brand and improved audio quality they will be successful in international, Europeans & Asians are more sophisticated customers they demand improved audio quality.
What IP does lululemon have? They have a very strong brand but happen to be in the apparel retailing business which is very competitive.
Skull is investing pretty heavily in the brand and organization to sustain growth. Some of the margin pressure is coming from this fact.
Skull has essentially turned a commodity like category into a branded, perishable, fashion item. Lots of small players will half-heartedly try to participate in this category so perhaps we'll see a shakeout but after the dust settles most all the volume will still go to the big 4.
Why is the VC sketchy? Not every company in Utah is the next overstock. On the flipside skull could be sold in a deal just like volcom was.
If skull merely maintains earnings of ~$1.20 a year with no growth for a few years then the downside will be limited from here. If they grow then we'll likely get a higher valuation on higher earnings.
In a brandless, seamless, flat world skull's margins would probably get whacked but the world is none of these things. I think this management team (yes they are young and still learning) is intelligently building a brand that will last for some time.
<<<What IP does lululemon have?>>
Engineered fabrics for comfort, seamlessness, wicking, and anti-stink properties.
"Many argue that SKUL’s margins are comparable to LULU and ZAGG, but those companies have IP that other companies cannot replicate without infringing on those companies IP. Headphones have been around for a while and SKUL's business technology is not defensible."
<<<They [lulu] have a very strong brand but happen to be in the apparel retailing business which is very competitive.>>>
Lulu surpasses their competition with innovaton (again to the point of IP) and thus able to limit inventory of particular styles to convey scarcity and a must-have, must-get-it-now-or-miss-out shopping experience. Quite the opposite, Skullcandy has demonstrated failure in achieving this attribute.
one other thing you mention "growth has to decline"
they just entered the eu market and dumped there distributor. why, cause they see more growth and of course higher margins.
thanks for answering my question anyway.
You still buying this? I still don't understand the fascination about this company on this board. Until today, it still traded at a higher multiple than Apple. I personally believe that Apple is a superior company to Skullcandy and deserves a higher multiple, but I know most people here disagree.
I referred to the slow down in "growth rates" (the second derivative) not growth which is a big distinction. For instance, if US GDP growth rate was changed to 1% versus current expectation of 2%+, you might interpret as positive since the GDP will still be growing but no one I know will interpret it as such. Note that the even analyst estimates project that 2012/2013 earnings growth rate declined from a projected 31.9% 90 days ago to 22.2%, as of today.
Even with the decline in SKUL's price, it still trades at a higher multiple than many companies, including Apple (ex-cash).
I realize that SKUL's margins are not low but its atypical for consumer electronics companies. Have you seen the margins for Sony, Dell, Logitech, HTC, etc? Maybe SKUL will turn out to be the single non-proprietary electronics company that can sustain abnormal margins and you will be right. For me, I have to bet with the odds.
"you are in a dream land"-thats true, I live in L.A....lala land
I'm not sure why people perceive "inventory liquidation" as a one-time event. Last time I checked, old inventory has always caused lower margins. I've seen lower margins for older merchandise at Toyota, BMW, Macy's Apple, etc. and none of these companies make excuses for it. It just a part of normal business. Why is it that you believe that SKUL's situation is exceptional?
I think your short interest figure is incorrect, and Yahoo's numbers correctly include additional shares from convertable securities. Look in SKUL's 10K:
"Upon the closing of the IPO, all shares of our preferred stock outstanding automatically converted into 4,507,720 shares of common stock. In addition, the convertible note converted into 3,862,124 shares of common stock and the related accrued interest of $5,575,000 was repaid with the IPO proceeds. "
I'm not certain which is correct...but its customary for preferred and conv debt investors to get piggyback registration rights, subject to the lockup provision. If you are a securities lawyer or know one and have better information, I'd appreciate a response.
"declining growth" huh
"low margins" what
"ipo should have 10-12" market cap of 300mil. ok
you are in dream land
yoy growth exceeds 25%
margins have increased with the exception of q1 due to inventory liquidation/packaging change.
wait and see what happens is all i can say. with 130% of the float short is 12 bucks all they can achieve?