Skullcandy Short Interest Finally Declines, Marking A Long-Term Reversal

Jan.12.12 | About: Skullcandy (SKUL)

This past Wednesday, after the market's close, NASDAQ's latest short interest update provided an excellent piece of news for Skullcandy (NASDAQ:SKUL) shareholders. For the first time since its IPO Skullcandy's short interest declined, going from 6,343,964 on December 15th, to 6,034,840 on December 30th. Although this only represents a decline of 5.12%, it's far better than the typical 10-15% increase in short interest we've seen since Skullcandy's July IPO.

This initial short interest decline could mean several things. The first and most logical conclusion would be that investors are getting less skeptical of Skullcandy's growth prospects, and thus closing out their short positions. Either that, or short sellers could be taking profits after Skullcandy's 36% decline in the past 6 months. Both reasons indicate that further downside for Skullcandy's share price appears to be limited at these levels (SKUL currently trading around $12.70).

Despite the short interest decline, Skullcandy still has a tremendous percentage of its float short. Considering the trade-able float is about 10.1 million and there are still 6.0 million shares short, the short interest still sits well above 50%. This provides a sizeable amount of ammunition for a short squeeze should Skullcandy surprise on its impending Q4 financial results. Although Skullcandy has already guided Q4 in line with previous estimates of $0.93 per share, the chance that they beat numbers when real figures come out still remains high. Skullcandy has already surprised EPS estimates in its first two quarters of being public by 16% and 21%, respectively.

After reporting year over year growth of 57% from Q3 2010 to Q3 2011, the current year over year growth estimate in Q4 (of 27.6%) seems far too low, especially considering Q4 is seasonally Skullcandy's best. New CEO Jeremy Andrus has started to show he is capable of beating and raising guidance consistently (in Q2 and Q3) and it looks like he will pull it off in Q4 again. On top of that analysts are projecting Skullcandy's revenue to go from $231.51 million in 2011 to $286.29 million in 2012. This implies modest annual sales growth of 23.7%. As we continue into 2012 this number is starting to look far too low, considering that sales growth from 2009-2010 was 35.6% and sales growth from 2010-2011 (projected) is 44.2%. The bottom line is that growth for Skullcandy has been accelerating (24% on an annual basis), yet analyst expectations for 2012 are forecasting a decline in growth rates (-46.3% on an annual basis). The numbers just don't add up, Skullcandy is poised to beat and raise guidance.

With Skullcandy only trading at 10.9x 2012 earnings, (despite the fact that estimates should soon be raised, see above) retaining the potential to crush Q4 estimates, and boasting a declining short interest, there is huge room for growth.

Additional disclosure: I'm long SKUL via out of the money March 2012 calls.