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Shares of Skullcandy (SKUL) started 2013 on a bad note. Shares of the developer and distributor of headphones and audio accessories to retailers have lost almost 12% already in the first three trading days of the year.

Dismal Share Price Performance

Skullcandy went public in July of 2011. At the time, the offering was a great success as the company was able to raise its offering price while boosting the size of the offering. Shares went eventually public at $20 per share and saw a healthy first day spike.

From that point in time, shares quickly fell to levels around $15 per share, a level at which shares were trading as recent as October of 2012. After lowering its full-year 2012 earnings outlook, shares kept falling in November and December, losing half their value in the past quarter alone.

Shares were furthermore plagued by a downgrade on Wednesday when Jefferies Group cut their rating for the shares from buy to underperform, accompanied with a $6 price target. Analyst Randal Konik of the firm is "increasingly concerned about promotional pressures and rising competition in the headphone market."

So after an almost 70% decline from the public offering price, is there an opportunity for long-term investors? Let's explore.

Valuation

Skullcandy ended its third quarter of 2012 with $1.9 million in cash and equivalents. The company operates with $5.2 million in short-term debt, for a small net debt position.

For the first nine months of 2012, Skullcandy generated revenues of $196.7 million. The company net earned $14.4 million for the period, or $0.51 per share. For the full year of 2012, Skullcandy guides for full-year revenues of $290-$300 million, on which it expects to earn $1.00-$1.04 per share, or roughly $30 million.

After the latest share price declines, the market values Skullcandy at roughly $189 million. This values the firm at 0.6 times annual revenues and 6-7 times annual earnings.

The company does not pay a dividend at the moment.

Some Historical Perspective

Investors in Skullcandy have had a hard time as mentioned above, especially as the share price decline accelerated in recent weeks.

Between 2008 and 2012, Skullcandy boosted its annual revenues from $80 million in 2008 to an estimated $295 million in 2012. With exception of 2010, the company has been profitable every year, although net profit margins have been under pressure for years already.

Investment Thesis

Investors penalize Skullcandy for missing its full-year earnings targets. At the presentation of its third quarter results, the company actually tightened its full-year sales outlook from $280-$300 million to $290-$300 million. The problem is that the company revised its full-year earnings outlook from $1.10-$1.20 per share to $1.00-$1.04 per share.

For the full year of 2012, the midpoint of the guidance implies that revenues are still expected to grow by 26.9%. Year-on-year revenue growth in the third quarter has slowed down to 17.2%, which stabilizes in the fourth quarter. The midpoint of the revenue guidance shows that revenues are expected to grow by 17.9% in the final quarter of the year.

So the problem is not revenue growth, it is competition eating into profit margins. The revised full-year outlook assumes that Skullcandy now believes that fourth quarter earnings are to come in between $0.49 and $0.53 per share, up just 11% from last year. The revision has been fairly aggressive as previously the company guided for fourth quarter earnings of $0.59-$0.69 per share.

While revenue and earnings growth undoubtedly has come under some pressure, they are still growing. At the same time the company trades at very fair valuation multiples and has essentially no debt. The aggressive short sell community has built up a sizable short position in the stock, something which could easily trigger a short-squeeze in case of optimistic news.

I will do some further research in the coming days, but might initiate a long position in the stock anticipating a rebound in the coming months.

Source: Skullcandy: Investors And Analysts Are Overreacting