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Summary

  • Zagg has been a primary beneficiary in the huge growth in domestic mobile device sales.
  • Zagg suffered its first revenue decline in seven years in 2013 citing increased competition.
  • Zagg's revenue base is heavily concentrated on a product, distribution and geographical level.
  • Internally developed OEM solutions from mobile device OEMs may prove to be the company's undoing.

As mobile has taken off in the United States, there have been a number of beneficiaries that have been able to take advantage of this boom through sales of complementary mobile products and accessories. One of the most prominent companies riding the wave has been Zagg (NASDAQ:ZAGG).

Brief Company Overview

Founded in 2005, Zagg is a Utah-based company that designs, manufactures and distributes "mobile accessory solutions". The company went public in September-2007 and as of the market close on March 28th, had a market cap of roughly $138 million.

The company's revenue has exploded over the past seven years, going from $5.1 million in 2007 to just under $220 million in 2013, as seen in the following chart ($mm):

2013

2012

2011

2010

2009

2008

2007

$219.4

$264.4

$179.1

$76.1

$38.4

$19.8

$5.1

In its most recent year, Zagg derived 85 percent of its revenue from indirect channels (big box retailers, online retailers, etc.), 9 percent from direct sales through its website, and 6 percent from its mall kiosks. Of its entire revenue base, there are two customers [presumed to be Best Buy (BBY) and Amazon (AMZN)] that account for greater than ten percent of its net sales. Additionally, the company's sales are heavily concentrated in the United States, which account for approximately 90 percent of its revenue.

In 2013, company derived its revenue from two main product categories, which accounted for over 70 percent of its net sales:

  1. 42 percent of net sales were attributed to its InvisibleShield product (screen protectors for mobile devices, such as smartphones and tablets); and,
  2. 29 percent of net sales were attributed to its tablet-companion Bluetooth keyboards (ZaggKeys).

Is the Party Over?

Zagg's latest financial results present an ominous turn for a company that has seen unprecedented growth over the last seven years, notably:

  1. Revenue declined by 17 percent year-over-year - its first decline in that seven-year period; and,
  2. Gross profit declined by 6 percent year-over-year.

In its filing, management attributed the year-over-year revenue decline to 1) increased competition; 2) decline in online sales across all product lines; 3) decline in sales through distribution partners; and 4) failure to expand distribution with wholesale customers and close significant business with new customers at the same rate in 2012.

The commentary is pretty much what you would expect from a company that saw its revenue decline by nearly 20 percent - issues across-the-board. However, the specific concerns that I see for a company that has flourished for a sustained period are as follows:

Commoditized Product Commanding Premium Prices:

Screen Protectors:

While Zagg sells its InvisibleShield as screen protectors predicated on "proprietary technology" that carry lifetime guarantees, consumers now see too many options in the marketplace that come at far cheaper prices.

For example, the "high definition" and "smudge proof" versions of Zagg's InvisibleShield screen protectors for Apple's (NASDAQ:AAPL) iPad Air retail for $34.99 on the company's website. If you were to search Amazon.com for iPad Air screen protectors, you would come across a high-definition screen protector made by a company called Tech Armor that costs $9.95 (70 percent less than Zagg's offering), and has a far higher customer rating; it also happens to be the "best seller" in the tablet screen protector product category.

A quick search of Amazon.com for iPad Air screen protectors yields 27,931 results - granted some of these hits may not be direct competitors to what Zagg is offering, and may not carry the lifetime guarantee, but when most are selling for under $10, it makes it very difficult for Zagg to compete on price, and in some cases, customer satisfaction - as seen by the Tech Armor offering discussed above.

Tablet Keyboards:

The other area that Zagg's revenue is heavily concentrated in is tablet keyboards, known as ZaggKeys - the Bluetooth companion that offers tablet owners the keyboard experience of a laptop. When browsing Zagg's online website, all of its iPad keyboards are priced at $99.99 or higher. Its "pro" line, which includes a back-light feature that lights up the keys, kicks the price up to $129.99.

I believe the problem that Zagg faces here is much like that of its screen protectors, but with an additional twist (covered in my next point). Other manufacturers with far bigger names in the peripherals space, including Logitech (NASDAQ:LOGI) and Belkin, are offering tablet keyboards (specifically for iPads) that are at near identical price-points. For example, Logitech's Ultrathin Keyboard Cover for the iPad Air is very highly rated on Amazon.com and sells for $79.99.

Distribution:

Perhaps the biggest challenge that Zagg faces is with distribution, where it relies on indirect sales channels for 85 percent of its revenue. It is no secret that a high percentage of Zagg's product offerings are designed for Apple devices - all you need to do is scan the website tab called "products" to see the brand concentration. Unfortunately for Zagg, the bigger names like Belkin and Logitech both have something that Zagg does not - distribution deals with Apple retail (online and in-store). The fact that Zagg does not have a distribution deal with Apple hurts it tremendously, especially when it is so easy and convenient to buy an iPad, screen protector, and keyboard case all at the same time. Keep in mind that Apple did roughly $2B in accessories sales during its December-2013 quarter - roughly ten times Zagg's annual revenue.

Zagg represents that it has two customers that comprise over 10% of its net sales. Based on my observation, I would bet those two customers are Best Buy and Amazon.com (mere speculation on my part). Best Buy has been in a precarious spot for a while now - ironically because of Amazon.com. Best Buy's tenuous position in the consumer electronics market inherently transfers risk to distributors (like Zagg) that heavily depend on its business. The problem with Amazon.com as a huge customer was outlined above - they sell product from everyone at every price point - as noted above, a search of iPad screen protectors (a major business for Zagg) yielded over 27,000 results. Amazon product searches commoditize whatever differentiating factors Zagg stakes claim to.

Internally Developed OEM Solutions:

Zagg's reliance on accessories for Apple devices could prove to be the company's ultimate undoing. Remember that Zagg's business is heavily concentrated in the United States (90 percent), a market where Apple controls the largest share of smartphones and tablets. If Apple is indeed developing stronger, scratch-resistant sapphire displays with GT Advanced Technologies (GTAT) as widely rumored, there may not be a need for future iPhone buyers to shell out an extra $20 or $30 for a Zagg screen protector. Now, one could argue that people would buy screen protectors even if the display was made out of diamonds, but there are a lot of people, myself included, that do not like the tactile feel that these screen protectors put on these touch-sensitive displays. Additionally, there will continue to be a lot of legacy iPhone users that will not be using sapphire displays (older generation models), but the mere possibility has to concern a company who derives over 40 percent of its revenue from screen protectors.

Microsoft (NASDAQ:MSFT) was the first to bring out an internally developed companion keyboard for its Surface tablet and my guess is, Apple is not far behind. When you look at the patent filings, there is no doubt that Apple is investigating, if not already developing a tablet cover that will also serve as a tactile or gesture-based keyboard. Once again, this does not mean that Zagg's tablet keyboard business goes away, but it likely will shrink.

One historical factor that one could argue relates to the "smart cover" introduction alongside the iPad 2 in March-2011. Zagg's share price took a big hit that day, but the effect on the company's performance proved to be overblown. Zagg actually showed near 50 percent revenue growth from 2011 to 2012. However, one thing to keep in mind is that Zagg did not have a direct competitor to the "smart cover" on the market at the time, and even purchasers of these Apple-designed covers also chose to purchase a screen protector - in a sense, the "smart cover" and screen protector were complementary products. An Apple-designed keyboard would be a replacement to Zagg's current keyboard offerings, not a complement.

The Bottom Line:

The mobile peripherals market has become heavily saturated, low margin areas that companies are using for ancillary revenue, rather than its core sales base. For the past seven years, Zagg has flourished on the coattails of the huge mobile smartphone and tablet revolution led by Apple. Were Zagg's results for 2013 a rare miscue or an ominous signs of things to come? As companies like Apple bring forth new products with new features and peripherals to support those products, my guess is that Zagg will be further challenged to diversify its revenue at a product, brand, and geographical level. Unfortunately, it may be too big of a mountain to climb compromising Zagg's shield for the past seven years.

Source: Is Zagg's Shield Invisible?