After An Epic Run, Skullcandy Is A Sell Ahead Of Earnings

Mar. 4.14 | About: Skullcandy (SKUL)

This is a tough article to write as I've been bullish on Skullcandy (NASDAQ:SKUL) for over a year now and feel that there were some very compelling reasons to go long. Many of these reasons have not changed. In fact in my last article, which was written when the stock was trading at around $5, I put a very optimistic price target of $35 on the stock. However, as circumstances change, so do my positions, and as a courtesy to those who may follow my advice, it is only right to fully disclose my sentiments after this recent run to the mid-$8s.

So with that said, following a near 50% gain on my initial investment, I simply feel that the risk/reward profile has shifted. My investment in SKUL was undoubtedly a huge success as I disclosed in my last article that I was "all-in" on SKUL in the high $5s. This means that I was fully invested, without any other positions or free cash. Some called that "insane," but I felt that at those levels there was limited to no downside and the balance sheet being as pristine as it is afforded me the comfort in taking a monster position. Undoubtedly while reading this article, some may cry foul as I was chest thumping a buy only recently at $5. However, just because SKUL was a buy at $5 does not automatically mean that the stock is still a buy at $8. While my long-term buy thesis isn't necessarily broken or confirmed (we won't find out until the earnings call on Thursday if it is), this is simply a situation of me finding more obvious investments in this bubble market of 2014. For the record, I have no plans of re-entering a SKUL position either long or short in the foreseeable future. The simple lack of liquidity makes buying or selling a sizable position very cumbersome and an often losing proposition.

Just so people understand clearly how I operate, I do not trade daily, or even weekly or monthly. My outlook is always for at least a 30% move, either long or short, and that normally takes some time. Although this article is not a macroeconomic one, overall I have a very bearish sentiment on the market. This is very important in explaining why I am no longer long. If I didn't feel that the market was not exponentially overvalued as a whole, I would certainly have a different risk/reward rating on continuing to hold SKUL (or any other stock for that matter). For disclosure sake, I have taken significant short positions today in the Direxion Russell 2000 Bullish 3x ETF (NYSEARCA:TNA), 3D Systems (NYSE:DDD), Tesla (NASDAQ:TSLA), Pandora (NYSE:P), World Acceptance Corp. (NASDAQ:WRLD) and Facebook (NASDAQ:FB). While I may be early here (both selling SKUL and shorting these other high fliers), I certainly do not want to be caught long ANYTHING when the music inevitably stops.

As I pondered holding through earnings the past few days and cashing in my well earned 50% gain, I did a lot of thinking and even some soul searching. I recalled a big trading mistake that I made a few years ago, where I bought in big into Sandridge Energy (NYSE:SD) at around $5 and sold for my largest gain ever at around $8, only to fall in love with the company story and kick myself daily as I watched it go as high as $14 before taking a monster position at $12 on leaps that expired worthless, thus leading to my largest loss ever. So instead of being happy of my big gain after a year long hold, I gave much of it back because I neglected the cardinal principle of what made me successful to begin with; buy grief, sell hype. Instead of being a sharp contrarian, like I was when I picked the Seahawks very publicly over the Broncos only to be ridiculed for 2 weeks until vindicated, I became just another sheeple like the public who rarely win in both sports betting and the stock market.

So, without further ado, I am going to outline a number of specific reasons of why I decided to cash my big gain and sell SKUL ahead of the Q4 earnings release on Thursday:

1) Revenue declines YOY for Q4 were projected in the last call to be IN LINE with the decline in Q3. This is about 1% greater decline than what is estimated at the moment. One analyst has not yet updated their targets despite the lowered guidance on the Q3 call, so the estimates for Q4 are artificially high. As a result, I think there is a risk that Skullcandy can miss both revenues and earnings estimates by as much as a couple million dollars and a few cents per share. With a recent 50% run-up in the PPS, even a small miss could spur a large sell-off, one that could bury the stock, sort of like Zagg (ZAGG), which is dead money. With all the current great short opportunities out there, I don't want to be sitting on dead money wishing I just cashed a big gain and moved on.

2) Another reason that I think revenues could come in soft in Q4 is that while I've been bullish on SKUL in a large part due to gaming, the fact that Microsoft (NASDAQ:MSFT) still does the adapter ready for the Astro Gaming sets to be XBOX One compatible will also hurt this quarter's numbers and Q1 2015 and possibly Q2 guidance (depending on when it is ultimately released). Astro Gaming wasn't much of a factor in Skullcandy earnings a couple years ago, but with revenues in the core business down so significantly, a few million dollars in Astro Gaming unrealized revenue due this compatibility issue could be a strong negative revenue and earnings catalyst.

3) RadioShack (NYSE:RSH) just reported terrible sales numbers, shocking even the most pessimistic followers of this company. As we all know, RadioShack was blamed for soft Skullcandy Q2 numbers (which led to a post-earnings sell-off into the high $4 range). Clearly with 1100 additional RadioShack stores being closed, I worry not only about Q4 Skullcandy sales numbers, but Q1 2015 guidance and forward. It just seems like a convenient excuse for a miss. I feel the same way about Target (NYSE:TGT), who is Skullcandy's largest customer by far and has been experiencing sales difficulty of its own resulting from the widely publicized data breach. Finally, you have Best Buy (NYSE:BBY), who is blaming poor recent sales on a weak holiday season and bad weather. With daily headlines like this, you might think the market would be trending down, but that is not the case. The problem is that RadioShack, Target and Best Buy make up the overwhelming majority of Skullcandy's sales. I try to use logic as much as possible in my thought process, and this one just does not add up to me. If guidance is based for the most part on the sales of these key retailers, and each one of them is experiencing epic times of hardship, where are the revenues going to come from? Smaller but also significant Skullcandy retailers like Tilly's (NYSE:TLYS) have been greatly underperforming as well. With Europe still soft and no real evidence of international sales penetration in Latin America, China, Japan or Canada, I'm not sure how the shortfall will be made up from the precipitous sales decline by the key retailers.

4) Right in the heart of Q4 in the midst of its most significant advertising initiative to date, Skullcandy's main celebrity promoter, Derrick Rose, gets injured and is out for the year. During the Q3 call, Hoby was banking on this major campaign, which included wrapping buses and plastering Chicago with Derrick Rose billboards. No fault of Skullcandy here and it did try to salvage the effort the best it could with a compassion campaign for the injured superstar, but many hopes were pinned on this initiative, and you have to imagine that it failed to meet or exceed expectations. This was a Q4, Q1 and Q2 2015 campaign that just backfired. The return of Derrick Rose and the surrounding big budget advertising campaign was a much hyped but complete failure that was undoubtedly very expensive.

5) Due to the extreme setbacks experienced by the key retailer customers that make up a majority of Skullcandy's sales, one might expect that the company shifted more distribution to the internet. So being an internet marketing and e-commerce expert with nearly 20 years of experience, I decided to check out how Skullcandy is doing online. The results of my online analysis was what really pushed me to ring the register and cash my 50% gains. First of all, Skullcandy is trending down in overall search volume and significantly so over the past 36 months and still trending down all the way into March 2014. This has not reversed or bottomed in any way. This is internet search volume and Google shopping volume. In comparison, Beats has been trending up this entire time with no evidence of giving up any ground. Skullcandy is simply being outclassed by the competition online. Its footprint is weak and the online demand for its product is thin. According to, Skullcandy website traffic has also been trending down for the past year or longer and Beats has again been trending up. Based on this, it is safe to say that online sales are inevitably weak compared to prior expectations of a bottom being put in the decline. Therefore, I see no evidence that the revenue declines have bottomed. The data for 2014, albeit limited, points to an even greater decline in both search, website traffic and online shopping for Skullcandy. This is really bad and it is getting worse. As an internet shopping expert, I just can't get behind a company that is failing so badly online.

Furthermore, I checked out how the Amazon (NASDAQ:AMZN) sales are going and using a proprietary method of "channel checks" that I use to gauge competitive information, and sales for the new Air Raid product are very slow at maybe 1 or 2 a day. Albeit this is just through Amazon, but the worst part is that the now flagship Crusher is experiencing some early signs of channel stuffing with the price now well below the MAP of $99.95. This was the CEO's top priority to make sure MAP pricing got held on Crusher, and so far, it looks like it failed. As we saw in 2012-2013, there is an awful lot of channel indigestion that lingers for many quarters or years after a sales channel is stuffed. Even with the channel stuffing, the sales rankings in the headphone space overall on Amazon seem abysmal. Both Beats, Sony (NYSE:SNE) and Panasonic (OTCPK:PCRFY), among other brands, seem to be very dominant in this marketplace. The only Skullcandy product with any traction at Amazon or even eBay (NASDAQ:EBAY) seems to be the Ink'd and it is selling for under $10. Not good for revenue numbers.

Finally, in comparison to Beats by Dr. Dre and overall, Skullcandy is doing a very poor job on the social networks. Its last Facebook post was on February 26, and it was an obscure one that made little sense to me about a graffiti artist and their "people talking about this" interaction level has been steadily in decline over the past year. I see that on their careers page they are hiring a social media director, but these slides are tough to reverse once they start. Skullcandy admittedly acted late on digital, everybody knows that and the CEO said this multiple times on calls, but I've seen no evidence that the social declines are indeed bottoming. Although their "likes" on Facebook and their "followers" on Twitter (NYSE:TWTR) have inched up over the past year, anybody can fake likes, so interaction is what I follow and they are down sharply. Almost nobody reads or comments on any Skullcandy posts lately and they are slowly becoming irrelevant to its target market of "irreverent youth." I see mostly product complaints from customers and very little praise. Again, Beats does a great job here if you want to see an example of what a strong social profile should look like.

In conclusion, based on the reasons illustrated above, I made my decision to cash in my 50% gain and begin to initiate a significant short position in the market as a whole, which I will be continuing to add to daily.

Disclosure: I am short DDD, TNA, TSLA, P, FB, WRLD. 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.