Everybody makes good calls and bad calls, and I believe that it is as important to own up to the losers as it is to take credit for the winners. Just a month after I published my long thesis for shares of ZAGG (ZAGG), the company issued a revenue warning for Q2 ($51 million, well below $59 million consensus) and lowered full-year guidance to $245 million to $252 million, well below the $273 million consensus. After a second disappointment in a row, is it time to simply throw in the towel on the name?
What Was This Warning Made Of?
The company had a number of excuses for the warning, citing the following major drivers:
- Lack of major device launches from major mobile device vendors
- Softness in the European market
- Slower-than-expected retail distribution expansion
I'm not sure that I buy the first argument. Samsung (SSNLF.PK) recently launched its Galaxy S IV and HTC rolled out its One. I believe that since ZAGG is a very Apple (AAPL) levered name, the statement probably should have more accurately read, "lack of major iPhone/iPad launch." What I find perplexing is that ZAGG very likely had visibility into the designs that would (and would not) be rolling out during the quarter, so I find it difficult to believe that this development came as a "surprise."
What I suspect is more likely is that as the high-end smartphone space has shown alarming signs of saturation, ZAGG saw weakness across its product lines. I also expect that as there has been a mix shift on the Apple side of things from the 9.7" iPad to the iPad Mini, ZAGG has suffered from a less favorable attach rate for its keyboard and tablet cover products.
I believe the European softness argument, but the main concern here is that this is a known quantity; European softness has been a major theme across ZAGG's most recent calls (and, indeed, throughout the entire tech landscape). So, I would expect that such weakness would have been already baked in to ZAGG's initial forecast for the quarter. This seems like a pretty flimsy excuse to perhaps draw attention away from either worse-than-expected execution issues or a poorer-than-expected demand environment.
The final argument -- that the retail distribution expansion was slower than expected -- is indicative of an execution problem. This likely wore away the last shred of credibility that management had with the Street, and I believe that regaining investor favor -- and this means being awarded anything but a bargain-basement multiple -- has now become a substantially more difficult uphill battle.
CEO Takes More Control
Interestingly, in the warning CEO Randy Hales emphasized that the company's sales/distribution strategy and execution was in need of serious work, and as a result he would be taking a leadership role in that division. To me this suggests that the revenue shortfall may have been skewed much more toward poor execution than an unexpectedly weak demand environment or the flimsy "Europe" excuse. On the downside, as mentioned above, this simply further damages what little credibility the company had after its recent misses/warnings. On the upside, this suggests that the company could conceivably fix the issues. At this point, however, given management's track record I would take a "wait and see" approach.
Time to Pack It In?
Shares of ZAGG are cheap at just under 4x EV/EBITDA, but in light of the revised estimates for the full year (which could be at significant risk of being revised further downward), as well as the serious credibility problem the firm has with management, they may represent a value trap. While my long thesis hinged on an Apple product refresh cycle driving results in the near term, it seems as if the company not only has significant execution problems, but that the end market is much less certain. However, even with an Apple product refresh, execution issues may well diminish shareholders' ability to benefit from said refresh cycle.
While I don't see a tremendous amount of downside, I see very little in the way of a meaningful upside catalyst. As a result, I believe the opportunity cost of owning shares in this environment is simply too high and drives an unfavorable risk/reward. I now step to the sidelines on ZAGG and await signs that management can regain credibility and once again drive top- and bottom-line growth commensurate with a name worthy of anything but a bargain-bin valuation.