There is no doubt that one of the more disappointing IPOs has been Skullcandy Inc. (SKUL). The stock quickly shot up to $23 from its IPO price of $20 in 2011, but since the IPO, the stock price has been on a slow and steady decline. Shares finally touched below $6 on February 8th on the news that its CEO and long term employee, Jeremy Andrus, was resigning to move to a PE shop. However, a brief review of Mr. Andrus' tenure as CEO and a further look at some of the recent happenings at the company may reveal a looming pop in the stock price of this habitual disappointment.
First I will explain my background with SKUL:
I have never been a bull in the stock and I have never much cared for its products, which I view as a commodity and not even a best in industry. In the low end segment, competition will continue to drive down prices of ear buds as there are many companies competing in the space and entry into the space is not difficult. Worse, SKUL's sales were likely hurt even further when APPL started packaging the iPhone 5 with its own ear buds. In the high end market, SKUL's products are behind Beats and Bose in both brand and quality. The company continues to push into the gaming space, but it remains to be seen how it does there. The new Xbox or PS4 could also be sold with its own high quality headsets like what APPL did with the iPhone5.
In late 2012 I thought the company's EV/EBITDA multiple of +8x was way too high relative to its peers because it had no significant way to differentiate itself. I suspect the high multiple was based on the company's growth, but growth had been waning over the past few quarters. I thought the company should have been on the lower end of its peer group and more like 5x-6x multiple with a value closer to $9 (see my comments on this article pre-November earnings announcement). I was short SKUL just below $15 leading up to its past earnings report in November 2012. Luckily for me, the company did disappoint back in November when it announced its Q3 earnings and guidance. Margins continued to erode, discounts were brought up in its earnings call and the shorts further piled it on and brought the stock down below $9, my estimated value at the time and the point where I covered.
Back to my current analysis on the company:
In Q4 of 2012 Mr. Andrus began filing SEC Form 4's as a part of a planned sale of his shares in the company. How aggressive was his selling? He sold over 100k shares in three months, which represented just under 10% of his holdings. For the CEO of a public company to be dumping shares at that rate is alarming in its own right, but it is extremely alarming when each sale was done at lower and lower prices. It almost appeared that he couldn't liquidate his holdings fast enough. Most investors see CEO actions like this as a major negative for a company.
Lo and behold, last week we maybe figured out that his heart hasn't been with SKUL for good reason. Mr. Andrus is bailing on the company to pursue another job in PE, and I don't think this jump (maybe partly push) could come at a better time for SKUL. Mr. Andrus and some others in management have not done a great job of creating shareholder value since the IPO and a change in management is needed.
From a management perspective, it is time that SKUL realizes that it is in a commodity business and it cannot rely on rapid growth alone to support its stock price. The company has now been public for 1.5 years and it must focus on its cost structure if it wants to survive. SGA as a percent of sales has ballooned since 2009 hitting 24% in 2009, 42% in 2012, 31% in 2011 and 37% for the first 9 months of 2012. For all his operations prowess, Mr. Andrus presided over a huge increase in costs without taking many mentionable measures to control them. SKUL has tried to control its distribution channels in Europe, but I haven't seen much else recently in any of the company's statements regarding cost controls. I am particularly concerned that one of SKUL's biggest expenses has been in advertising and the use of celebrities/athletes to promote the brand. This appears to be an attempt to directly compete with Beats, but I am not so sure the return per celebrity/athlete is worth it. The practice needs some fresh scrutiny and some marketing contracts should not be renewed. In general, costs need a top to bottom review to make SKUL a leaner manufacturer.
|9 mo 2012||2011||2010||2009|
|SGA % of Sales||37%||32%||42%||24%|
So what's good now?
In my view the current EV/EBITDA multiple is far too low for this company, even when viewed as being in a commodity business. The company's LTM EBITDA is around $50M and applying my 5x multiple values the company at around $9.25. Not much has changed since my last valuation. However, the company currently trades around 3.3x EV/EBITDA, which is far below any other company in the headphone or other commoditized electronic industries. SKUL really only has one product offering, but it is still reasonable to compare it to other more diversified audio and electronic manufacturers. Multiples of SKUL's closest peers (HAR, VOXX, SNE, PLT) have been between 5x-10x, but many of these companies have numerous other product offerings that would be higher margin than headphones.
Even with falling margins, I still think a 5x EV/EBITDA multiple for SKUL is reasonable based on this peer set. NOK is a great example of a struggling phone manufacturer and using its low 4x EV/EBITDA multiple would still value SKUL at $7.40. SKUL is still growing rapidly, unlike NOK, and has a lot of market share to gain in places like Europe and Asia, so I'm not sure it warrants a valuation as low as NOK.
Aside from the seemingly low valuation, there are two other things that have helped me change my mind on the stock, at least as a short term trade. First, in late January the company amended its credit facility to allow it to draw up to $28M on the line to use for share repurchases. At its current valuation that would mean the company could repurchase about 17% of its float. This is the only action that I believe could meaningfully cause a short squeeze due to the continued high short interest in the stock. People have thrown out the short squeeze idea for months now with no real catalyst to cause it. A meaningful share buyback (say $20M-$25M) could signal to investors that management believes in its stock and is ready to take action to support its stock price. In the press release announcing Mr. Andrus' departure, Jeff Kearl, the Chairman, said that Rick Alden, founder and interim CEO, "will help to make the changes necessary to continue improving financial performance and to enhance shareholder value." I cannot find any other instances of SKUL management referencing shareholder value. It is especially interesting that it is coming after the credit agreement amendment just a few weeks ago. It is speculative to think that when earnings are released in March that a buyback will also be announced. However, the company has minimal debt currently, and if management believes in the company and believes that the $6 valuation is too low, then it should consider a buyback program to support the stock and give back to shareholders.
Second, I think the potential for a new CEO that can do a better job of managing costs can help stabilize margins of the company. There is no indication of who will be the next CEO, but I am hopeful that Mr. Kearl's statement above about "improving financial performance" is an indication that the board understands the business that it is in. The prices of its ear bud products on Amazon.com are heavily discounted already and these will likely be the new pricing points going forward. And yes, SKUL will continue to grow rapidly as it expands in Europe, Asia and elsewhere, but that growth is deteriorating and costs now need to become a bigger focus for the company.
I do not know what next steps management will take, but a few astute moves could meaningfully boost its share price. It will take a while for a real turnaround to play out, but if any significant action is taken by the board, look for that ever elusive short squeeze to finally happen.
Additional disclosure: I am considering a long position, most likely in options with an expiration after earnings, in SKUL after last week's rout.