Can Skullcandy Turn The Dial Up To 11?

| About: Skullcandy (SKUL)

Skullcandy (NASDAQ:SKUL) finally found bottom after losing two thirds of its IPO valuation in mid-2011. The headphone maker initially opened for trading above $20 per share. Sadly, it has been a long, painful ride down for shareholders, who recently saw shares dip below $5 after posting first quarter results on May 2nd.

Many thought a bottom might have been in place when shares started to trade strongly headed into the fourth quarter earnings back in February. While the results were good, the guidance was not. The CEO had just left the company and sales were estimated to be down ~30% year-over-year for the next quarter.

Well, Skullcandy was pretty close to estimates this quarter, with sales down just under 30% from the previous quarter. Management mainly cited repackaging efforts and product rebranding for the lack of sales. It should also be noted that sales were not down merely for lack of demand, but a deliberate, self-inflicted effort to right the fundamental ship.

Let's just be frank: this is not a quick turnaround story. But nonetheless, I do believe it is a turnaround story in the making. The company has no long-term debt, which is one of the better things to find when looking at a company's balance sheet. The company has also found a new CEO, Hoby Darling. Darling was previously at Nike (NYSE:NKE), and before that, Volcom. His specialty is working with other companies and orchestrating deals. He completed a takeover bid with a private company for Volcom -- which is usually good for shareholders -- and completed many other business deals while at Nike with other brands.

In the most recent conference call, Darling estimated sales to be a bit better than the recent quarter. He also stressed how much better sales were doing for the new Crusher headphones. The Crusher was meant to aim squarely at the mid- to upper-end of pricey headphones.

The goal here is to hit that "sweet spot" of supply and demand. Too expensive, and the sales will be too little. Too cheap and sales will be higher, but the margins will be lower and revenues will still come in weak. If it can -- and what it's trying to do -- is hit that sweet spot, to maximize revenues and boost margins, something that's clearly ailing the stock price.

Darling believes in the company, as he made clear in the conference call, and is putting his money where his mouth is. On top of his stock-option compensation, Darling purchased an initial 10,000 shares last week at an aggregate price of $5.41.

While not an overwhelming amount, it is nice to see a CEO who believes in his company and purchases shares with the stock down roughly 40% year-to-date.

Furthermore, last year's acquisition of Astro Gaming is proving to be very wise. Gaming continues to be a relatively untapped area where sales of headphones with microphones are selling great. Gaming has become a huge part of the younger generation. Online gaming has become even bigger. This is an area where Skullcandy can really take advantage of going forward.

The branding of Skullcandy is amazing. People recognize the brand almost instantly. By continuing to push international sales and making a name for itself in gaming, Skullcandy can continue to see repeat customers.

Overall, I think Skullcandy's share price will go up. Sales will still be down compared to a year ago for a while and the stock will still have its struggles. But eventually I think the stock will recover enough and become a solid takeover target if it can successfully do these three things:

1. Maximize the potential of a select few headphones, most notably the Crusher

2. See solid growth in both international sales and in gaming sales

3. Don't bring on any extra debt. The only debt that I would personally like to see would be for share repurchasing.

As long as things get better from here, which I expect them too, the share price should go up. Even with shares in the $7 to $8 range, a takeover bid in the double digits wouldn't be an outrageous thought, which would make it nearly a double, with shares at $5.50.

Disclosure: I am long SKUL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I am long Skullcandy in the form of LEAP call options.