Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.
As the stock market continues to soar, investors are on the lookout for fast growing companies that have the ability to expand their reach into additional markets and regions of the world. While looking at some recent earnings reports, one company really stood out as a potential breakout star. That company is Parametric Sound Corporation (NASDAQ:PAMT). Below are several reasons why investors should strongly consider adding Parametric Sound to their portfolio.
Parametric Sound Corporation is a pioneering innovator of directed audio solutions. With a substantial body of intellectual property, Parametric Sound is the foremost authority in the application of acoustic technology to beam sound to target a specific listening area without the ambient noise of traditional speakers. The company is targeting its technology for new uses in consumer markets including computers, video gaming, televisions, home audio and health care.
Recent Financial Performance
Before investing in small-cap technology companies, I like to analyze the recent revenue growth over the past couple of years. In Parametric Sound's case, the growth has been extremely encouraging. For the fiscal year ended September 30th, 2013, the company generated total revenue of $562,902, a year-over-year increase of more than 140%. From 2011 to 2012, Parametric Sound actually generated year-over-year revenue growth of nearly 200%.
The company has also been steadily increasing its gross profit. For the fiscal year 2011, gross profit came in at roughly $44,000. For 2012, it was $113,507. And for the most recent year, it was $270,573.
The balance sheet also looks promising as the company only has 1 long-term item on the books, a capital lease obligation totaling only $94,611. The company has available cash of nearly $1.6 million which means the company could easily pay back the long-term debt. In fact, the company's own revenue stream could pay back the obligation without having to dip into the cash fund.
This strong financial performance is likely the cause of the soaring share price during the past couple of years.
Parametric Sound's Soaring Share Price
Thanks to the company generating substantial revenue growth, shareholders have flocked to gobble up the shares. During the past 2 years, Parametric Sound's share price has soared by nearly 150%.
The recent dip in share price appears to offer long-term investors a promising entry point as shares slid on the recent quarterly earnings report despite the company generating significant year-over-year increases. There are several reasons why long-term investors should have confidence that the company will continue to expand and grow over the next few years.
Strong Product Line - HyperSound Technology
Parametric Sound is primarily known for being the creator of the HyperSound System. Instead of using a vibrating membrane like traditional speakers, HyperSound converts audible tones into ultrasonic waves transmitted at frequencies beyond human hearing. These audible tones are projected alone an air beam of silent ultrasound energy. This sound can be directed to just about any desired point in the listening environment. HyperSound offers 4 main advantages to traditional speakers:
- Innovative: Sound creation along a directional ultrasonic beam fundamentally changes how sound is created and delivered to listeners
- Immersive: Emitter technology beams audio like a flashlight and immerses the listener in clear, distinct, 3D sound
- Controlled: Unique ability to control the placement of sound
- Disruptive: The potential to dramatically change sound amplification and hearing loss markets
As I mentioned in the introductory paragraph, Parametric Sound's HyperSound technology can be applied to several large markets that could result in significant revenue generation in the future. A few of those opportunities include:
- Health Care: The World Health Organization estimates that over 48 million Americans suffer from hearing loss. 360 million+ across the world are currently living with disabling hearing loss.
- Gambling: Over 4 million casino slot machines are in operation that could benefit from HyperSound.
- Home Theater Systems: 237 million televisions were sold in 2012.
- Tablets: The Computer Industry Almanac report estimates that 185 million tablets are expected to be sold in 2015.
- Gaming Consoles: Price Waterhouse Coopers estimates that the global video game market should expand to $83 billion by 2016. Based on the recent sales volume that the Xbox One and the PS4 generated on their opening day, the market could be even larger than expected.
The above 5 opportunities are just a handful of addressable markets for the HyperSound System. In order to quickly expand into them, Parametric Sound is considering a merger with Turtle Beach. Let's examine why that might be a promising opportunity.
Turtle Beach's Reach
Turtle Beach has been an audio technology innovator for more than 3 decades and is the leader in advanced gaming headsets. The company specializes in allowing video game players to experience high-quality, immersive sound and the ability to communicate with others while playing video games. The company has developed a line of Ear Force gaming headsets which can be used with Xbox, Playstation and Wii game consoles, handheld consoles, Macs, PCs and mobile devices.
In 2013, Turtle Beach announced three major partnerships:
- Microsoft: Turtle Beach is developing audio solutions for the next-generation Xbox One, including the officially licensed XO FOUR and XO SEVEN surrounds sound headsets.
- Activision: A two-year exclusive agreement in which Turtle Beach will launch a new line of limited edition headsets optimized for Call of Duty Ghosts.
- Marvel: Turtle Beach is creating the Marvel SEVEN, a premium entertainment headset featuring interchangeable speaker plates.
In addition to the above partnerships, Turtle Beach has excellent distribution across the world. The company has developed distribution rights with 27,000 storefronts in 44 countries. This mass reach enabled the company to generate more than $200 million in total revenue during 2012. Additionally, Turtle Beach had the #1 U.S. market share in the 2012 gaming headset market, even ahead of Microsoft.
In light of this financial strength, the company has developed a 5 year plan to increase revenue by 400% to $1 billion. In order to achieve that revenue goal, Turtle Beach would like to push the HyperSound System into additional markets such as consumer, commercial and health care applications. The company would also like to develop and/or acquire complementary audio technologies and products.
It appears that the merger would benefit both parties. Because of Parametric Sound's innovation in the audio and 3d audio markets and Turtle Beach's dominance in the gaming headset market, the merger would seem to be a natural fit. The deal would allow both companies the expansion they seem to desire while building out a more efficient global supply chain. This would help minimize costs while ramping up revenue, something that every investor likes to see.
Despite the potential of Parametric Sound, investors must also consider the risks of investing in a small-cap company. The merger opportunity represents both a lot of potential but also the opportunity of less than desired results. Wharton Business School analyzed mergers and their conclusion was that between 50% and 80% of mergers don't produce the desired results. This can be because of a number of reasons but the primary one is that it can be difficult to integrate all divisions of the acquired company.
This doesn't mean that these mergers are failures. It simply means that the initial expectations weren't met. The end result could still have been positive but not to the extent initially thought. So investors must analyze the risk/reward of a merger opportunity and decide whether it is worth it.
A second risk is competition in the gaming headset market. Turtle Beach currently is the leader by a wide margin but given some of the competitors in the space, such as Sony and Microsoft, the dominance may not continue forever. Microsoft and Sony are known for their strong research and development efforts. Turtle Beach will likely be the leader for years to come although it is possible that its share may dwindle.
Although there risks associated with both the company and the merger opportunity, I believe the potential for share price appreciation far outweighs the potential of a decline. Parametric Sound has demonstrated that they can operate efficiently as a standalone entity. The last 3 years of financial performance indicate that. However, this merger opportunity represents an opportunity to expand into other markets at a much quicker pace than Parametric Sound could execute on its own. Given that, investors may want to consider taking at least a small position in the company ahead of the merger decision.