This is a continuation of my article "Apple Pure Play: ZAGG poised for another 400% Bull Run." I will address the bear case while at the same time addressing the "short and distort" scheme on ZAGG. I am sure you can read between the lines.
As many know, there has been a "short and distort" scheme waged on ZAGG (NASDAQ:ZAGG) for quite some time. Looking at the rumors that have been spread over the years gives a pretty clear picture of how shorts have attacked ZAGG. Shorts typically spread extremely negative rumors in order to make investors run for the exits and to prevent new investors from buying. Even if the rumors turn out to not be true, the shorts will not acknowledge the truth and move on to the next rumor. The rumors are spread from either shorts, short hedge funds, or third parties affiliated with the shorts. Short and distort schemes typically direct rumors in a few key categories, although just like with lies, the possibilities are endless.
The usual short rumors that are spread include: 1) accounting issues with the company or that the company is going bankrupt any day 2) Business is going off a cliff right now or the product is now obsolete or is getting rejected by all customers at the same exact time and 3) SEC investigation causing resignations and insiders fleeing. To add to the drama, the information usually comes from friendly people "with no interest" who are just "looking out." Somehow the rumors come from people that must have the best connections in the world as they know all the right experts, lawyers, analysts, insiders, competitors, distributors, relatives, etc.
Almost all of the time, the attacks are made on microcap companies that have less volume and are easier to control. All positives on the company are irrelevant to shorts. The short & distort scheme has numerous associates spreading vicous rumors through the media, blogs, and message boards in an attempt to drown out any bull message. The goal is to drive the price down any way they can. Hedge funds short high, employ short and distort, then cover at a much lower price, and then repeat on another company.
They can be spotted easily as the messages often include postings such as:
- "This is the biggest PoS I have ever seen"
- "Respected friend in finance industry says stock has many red flags"
- "I have inside information that recent acquisition was a disaster"
- "This stock is going to zero"
- "Experts say this is a shell company"
- "There are no earnings here, this is a pump and dump"
- "Fraud, Scam, Ponzi Scheme"
- "I have inside information the quarter was a disaster"
- "I have inside information that auditor is about to drop them"
- "Company is going to declare bankruptcy any day"
- "Friend says FBI is in their parking lot"
- "Expert industry friend says technology is worthless"
- "Consulted a lawyer that says...."
- "At investor conference, I heard people say....."
- "Know people affiliated with clinical trial that drug is a bust"
- "The product will never launch"
- "They are about to default on debt"
- "Insiders are about to dump all of their stock"
- "Expert says they will lose the big court case"
- "The store/restaurant/hotel is a ghost town"
The vast majority of these messages are from shorts trying to get the price down. When you read the list above, even you would laugh at how absurd these comments sound. For everyday investors or timid mutual fund managers, this can make them run to the exits. Why not? Some "friendly advisor" said the FBI was in the parking lot of the company HQ. Run for cover!
Currently, short and distort campaigns are not often prosecuted by the SEC, which gives free reign on spreading rumors. With ZAGG having over a 41% short interest at the end of last December, there is no way that a short and distort scheme is not happening in a small microcrap stock such as ZAGG. Some hedge funds specialize in this scheme. The following are the main ZAGG myths from recent short and distort campaigns that I will easily dispell:
"Worthless Pennies" myths:
Bad myth 1) He said he had inside knowledge that said Best Buy (NYSE:BBY) was going to drop ZAGG numerous times since 2010. He also has hinted at massive sales returns at a moments notice from Best Buy. He also wrote in 2010 that said he had a friend that said ZAGG was kicked out of Target (NYSE:TGT).
Reality: ZAGG obviously has not been dropped. In fact, Best Buy has expanded SKU counts and remains the strongest retail relationship of ZAGG. As ZAGG has entered other retailers, I hear this rumor less. Note that he says he was "quite friendly" with a former Best Buy Senior Exec. This guy seems to have great luck at getting the right contacts at the right time. Since 2010, ZAGG has not only remained in Target, but expanded the number of SKUs. It is funny how this guy has friends at Target too.
Food for thought: It is funny how the one public short (at the time) on ZAGG also happens to be the only one to have inside knowledge of the biggest customer dropping it. The bulls don't know. The bears don't know. But this guy does. Years later, this rumor looks ridiculous.
Bad myth 2) He said he knew someone who investigated the ZAGG distributor and found no ZAGG inventory a year ago. It was his expert witness. He said the facility had no ZAGG products. He is insinuating that the ZAGG inventory is in a "boiler room" warehouse. This is very similar to Chinese rumors of empty offices in China.
Reality: Inventory obviously does exist. ZAGG continues to grow its inventory as sales have doubled. Retailers get stocked on time. Inventory buildup is used support expanding SKU count. It is amazing that this bear has friends that are somehow able to tour facilities of companies he is shorting.
This is ironic because ZAGG eventually got criticized for having almost double the inventory despite doubling sales. In a December Benzinga interview with the CEO, it was pointed out that inventory actually decreased by 2 percent on a comparative inventory to sales basis.
On a year-over-year basis from the third quarter of 2011, ZAGG's inventories increased nearly 90% from $18 million to $34.1 million. However, revenue over the same timeframe has increased about 99% from $23.06 million to $45.89 million.
Bad myth 3) He said "Golden Shellback" was a big cover up "shellgame" in 2010. Hinted that the money was a payoff of some sort. In 2009, he said that parylene coating has been around and questioned why ZAGG had paid for the rights to it.
Reality: With CES 2012 demonstration and HZO launching in 2012 along with the reception in garnered, the "Golden Shellback" looks like it was a great acquisition. It was the foundation of the HZO company. There are ongoing talks with numerous major manufacturers. There has since been four different venture capital investments totaling over $10M into HZO. He didn't understand the differences in outside parylene coating and parylene coating with internal circuitry.
Bad myth 4) He said in 2010 he knew the earnings didn't really exist because the auditor was shady. When ZAGG moved on to KPMG, one of the big 4 auditor firms, he questioned the rationale and timing. He said in Jan 2010 that there was no way KMPG would sign off on the 10K with the scary article titled "KPMG Judgement Day." He said that the former auditor probably found something and refused to sign, and thus KPMG would find the same and drop them. In the final blow, he said ZAGG would then get delisted from the NASDAQ. He said it was about to go to pennies in March 2011.
Reality: ZAGG hired KMPG at the end of 2010 who signed off on the financial statements. ZAGG had a record year in 2010 that doubled revenue from the previous year. Plus, I probably don't have to tell you that ZAGG still trades on the NASDAQ. ZAGG went on to shoot up to $17 last summer before the recent pull back.
Bad myth 5) He said ZAGG keyboards were cheap and that nobody would buy them in 2010.
Reality: Since the report was written immediately after the ZAGGmate launch, keyboards have been a big development for ZAGG in 2011. In April 2011, ZAGG signed a deal with Logitech for the ZAGGmate keyboard. Additional keyboards have been launched in 2011. This has been the biggest success of ZAGG after the Invisible Shield.
Bad myth 5.5) He did some damage control on the day the big Logitech iPad keyboard deal was announced. He had to get creative. He said ZAGG had to deal to Logitech (NASDAQ:LOGI) because it failed in sale hurdles and that the developer of the ZAGGmate really went straight to Logitech. He hints that ZAGG is cut out of the deal. He hints this is all about to become public.
Reality: ZAGG signed the deal with Logitech. The iPad keyboards are a big seller as indicated in the last couple Logitech conference calls. According to the last investor presentation, ZAGG hired the creator of the ZAGGmate who is now an employee of the company. You can also see him in some of the product video interviews.
Food for thought: Although none of his predictions on the ZAGG keyboard business came true, did he come out and take his comments back? Nope, he made something completely new up that was even more preposterous than the last. When that turned out as another lie, there was nothing but silence on the issue. For those that want some history to "Worthless Pennies'" worthless market analysis, you should also read his report in 2010 that says the iPad will be a zero sum game for Apple because it will cannibalize Mac and desktop sales. He thinks the boom in android tablets will dominate Apple like the 80s. Years later, and especially after looking at Apple's last quarter, this guy's predictions seem to be wrong no matter what company he writes about. Perhaps he does not have an expert friend in Cupertino.
Bad myth 6) As funny as it sounds now, he said at the end of 2010 that said iFrogz was a threat to ZAGG with iFrogz screen protectors.
Reality: This is pretty ironic since ZAGG acquired iFrogz in June 2011. As long as investors see the expanding ZAGG SKU count in retailers and no major competitor expanding, then we can rest assured the market position is solid. Retailers typically only expand SKU counts quarter after quarter if the product is selling well.
Food for thought: Do you think this short lives in New York City where there are not many major retailers (Wal-Mart (NYSE:WMT), Target, Best Buy)? If he lived in any normal American town, he could see with his own eyes the expanding SKU counts. Does he think he can bank on other mutual fund managers not actually shopping in retail stores?
Bad myth 7) Although conflicting with his previous claim, he said ZAGG had too much raw materials (polyeurothane tape) in the spring of 2011. He stated that there were millions of feet of it and implied that it was never going to see the light of day.
Reality: The tape is the main material in making the invisible shield. The tape has to be cut and packaged. ZAGG purchases in large quantities in order to get a quantity discount. As a result, ZAGG sold 15 million invisible shields in 2011 alone. This was more than their entire company history combined. As ZAGG sells more invisible shields each year, expect raw materials to go up. If someday raw materials was going up and sales was going down, then that would be a red flag.
Food for thought: How else does he think ZAGG could double sales each year in a retail product business without increasing inventory? If inventory (and probably things like account receivables) did not grow but sales did for retail products, that would probably be the red flag. Inventory growing roughly the same rate of sales is generally a good thing in retail.
Bad myth 8) Back in December 2010, he said that ZAGG was a pump and dump. Like with most shorts, he pounced on an insider sell as the signal that the dump was in. He said ZAGG was going to go to pennies.
Reality: I could copy the stock chart, but I think everyone knows that ZAGG is not a pump and dump. It is a real company with growing earnings each year. It has a real accounting firm. The price is currently around $9 per share. Pump and dumps usually occur in the OTC market. Pump and dumps usually happen from anywhere between a few days to a few months. ZAGG has been increasing earnings for the last 5 years.
Bad myth 9) He said the CEO was essentially a cheesy pitchman like Billy Mays trying to sell a worthless product. Additionally, "Worthless Pennies" wrote a long article in October 2010 taking aim at the ZAGG patent application. Essentially, he says the lawsuit from Andrew Mason and the spray/squeegee kit will have huge detrimental effect to ZAGG. He actually goes as far as pumps the virtue of the Mason patent and how close it is to the process of installing screen covers. He almost implies the installation kit is like the secret sauce behind the Invisible Shield's success. Like with his other research, he had an expert, this time a lawyer to look at the patent. He says that the lawsuit would cost tens of millions in "historical fines" and cause a recurring royalty. It almost sounds like the end of the world for the company, right?
Reality: I did get a good laugh when he compared Robert Pederson's pitch style to Billy Mays, because if you have seen videos of him (college lecture and investor conferences) his enthusiasm does make him seem very optimistic. With the results ZAGG has produced since its inception, and the market potential in the future, I can totally see why. I would be thrilled if my company was riding high on the coat tails of the largest company in the world at the center at one of the largest technological revolutions ever. I have to note though, he has toned it down with his appearance on CNBC last summer and then on Mad Money with Jim Cramer in October.
As for the "end of the world" scenario that was described, the lawsuit was dropped against ZAGG when it acquired Andrew Mason's patent with stock. Andrew Mason essentially received stock options with additional incentives if ZAGG wins in further lawsuits. ZAGG turned the lawsuit against its competitors. As the final blow against the argument, ZAGG was granted its own exclusive patent on wrapping electronic devices in the summer of 2011. The combination of these patents are deadly to competitors. ZAGG already has had competitors settle.
Food for thought: Since "Worthless Pennies" had his expert lawyer say that with the Mason patent all screen protector companies would be crippled in fines and royalties, why does he not think it would now be a huge advantage to ZAGG now that it owns the patent? How about combining this with the patent that he never thought ZAGG would receive in wrapping electronic devices?
Bad myth 10) Back in the summer of 2010, he came out with an article saying that investors should get out of ZAGG because the Invisible Shield is a commodity product. Like with bears today, he hinted that competition was about to make sales collapse at ZAGG.
Reality: "Worthless Pennies" had extremely bad timing as this prediction was made also during the full iPhone 4 launch quarter. Up to that time, it was the biggest quarter in ZAGG history. ZAGG sales continued to shoot higher after the prediction. I did see that he did not repeat his mistake during the recent iPhone 4S launch quarter although he did have some gripes on ZAGG sales promotions recently.
Ok Info 1) He did have some interesting information on the reverse merger history 5 years ago when ZAGG only made $5M a year (compared to over $175M in 2011). Interesting read, but at the same time it actually highlights the exponential growth of ZAGG. Since the report, ZAGG has doubled its growth again. This seems equivalent to saying that Apple once started in a garage and had little to no revenue at one point. Somehow, early beginning stories are controversial. ZAGG actually started out a guy's garage trying to protect his watch.
Ok Info 2) When ZAGG was much smaller they were seeking new investors. Frankly, this is what most small companies do when starting out. They might have hired Mr. Cassell and Mr. Davidson to help promote the stock in 2008 and part of 2009. I really don't know, nor does it make a difference to me based on the company performance since then. Additionally, I also know ZAGG used Redchip to help promote the stock. Brokerage houses essentially do this during initial public offerings. This can be looked at a couple ways.
Back in 2008, ZAGG had just grown from $5 million in annual revenues to $19 million. People were skeptical about the business for many of the reasons current bears are skeptical. They were afraid the business might peak or competition would take them out. Zagg did not own any patents back then. ZAGG had just gone from selling exclusively online to placing some SKUs in Best Buy.
The relatively young CEO stated his goal was to create a billion dollar business in ZAGG. If ZAGG earnings and revenue indeed had peaked and crashed, then I would agree with Mr.Boyd. However, since then ZAGG has continued to double its revenues year after year. ZAGG has diversified product offerings in keyboards, power chargers, more advanced Invisible Shields and protective coverings. ZAGG acquired iFrogz and sells cases and audio accessories. Annual revenue is now over $175 million. With that performance record, I have to side with bulls on ZAGG. Even Microsoft (NASDAQ:MSFT) was once small. One of the big regrets of Ross Perot was turning down investing in tiny Microsoft when a scruffy Bill Gates went to see him. Most companies start out from nothing.
Bad myth 1) He predicted new auditor KPMG was going "find stuff' and force write downs.
Reality: In March 2011, the ZAGG annual report was signed off by KMPG and filed to the SEC. There has not been any significant inventory writedowns since the report.
Bad myth 2) He predicted competition was going to destroy ZAGG in 2011.
Reality: ZAGG experienced record sales in subsequent quarters. The iPad 2 Invisible Shields and keyboards were huge sellers for ZAGG. ZAGG received a US patent for wrapping electronic devices in film. No major competitor has been able to emerge besides Belkin in Target. ZAGG sold more Invisible Shields in 2011 (15 million units) than they have in their entire history combined. Zagg is entering 2012 with many catalysts as described in previous article. 2012 is the year of the iPad 3 and the iPhone 5.
Bad myth 3) He focuses substantial time on friends of ZAGG executives. It reads like an expose in the national enquirer and not fundamental analysis of a company.
Reality: It appears as though a $500K marketing deal went sour in 2008. In light of the exponential sales in 2011, this doesn't seem like it had any impact. There is also mention of a friend of the CEO that had to settle with the SEC a few years ago. It is always a pretty effective bear method to insight fear by mentioning the SEC, but if the person in question is not an executive nor employed by ZAGG, I found this to be a mute point. This is like saying Mark Zuckerberg once designed websites for a guy who defrauded people in a wood chip enterprise. Attacking a company by attacking friends of executives? Does anyone believe any of this?
Bad myth 4) He contends that ZAGG would have looked more legitimate if it had an IPO.
Reality: Reverse mergers typically do have a stink on it. Typically though, the stink has to do with Chinese companies that try to circumvent the listing process. The Chinese companies have headquarters in countries like the Cayman Islands. The Chinese insiders don't live in the US and can't be prosecuted. If ZAGG went public the traditional way, it would probably still be private. It would have been significantly harder to do acquisitions since iFrogz was bough with half stock. ZAGG is a US company with one of the major 4 accounting firms auditing them and has doubled revenues annually the last 5 years. ZAGG executives live in the United States.
Good Info 1) Just like Mr.Boyd, Citron pounced on failure of ZAGGbox and resignation of a director. Overall, the Citron bear article seems a little more well written than most bear pieces. The ZAGGbox was a big failure. A director was essentially fired over the whole thing. It was a bad business decision, although ZAGG limited their risk with the project by taking small steps with it and not banking its future on it. ZAGG only spent $4M to license the technology (against real estate collateral) and placed a small initial order. The R&D alone was $35 million from the manufacturer so the development work had already been done. ZAGG tried to market it but there was no demand for a $1000+ set top box. By only investing a a few million (against real estate collateral) ZAGG is actually significantly more prudent investors than Citron gives it credit for.
Good Info 2) Citron pounced on business mistakes before ZAGG was listed on the Nasdaq and traded OTC. When I read the article, I did not remember the "Rockstix" in 2008. It was only out one season which makes me think it was not very profitable. I don't know if it was actually sold in a store or just online. It could also just have been marginally profitable or break even. It is hard for me to tell. ZAGG was a much smaller company with little retail space unlike today. This was 4 years ago. ZAGG was barely in Best Buy. Since I argue that successful products typically expand SKU counts over numerous quarters and years, I will side with Citron's take.
Good Info 3) Citron pounced on Appspace not becoming the "Myspace of apps." I remember it launching a few years ago but the site did not take off despite the app market exploding. The idea of playing the smartphone revolution was in the right place. ZAGG had no chance against iTunes. Good information though, because it failed in such a way that I even forgot about it. ZAGG quietly closed the Appspace effort like many companies do with failed plans. ZAGG did not invest much money into this venture. It was a failure, nonetheless.
Bad myth 1) Citron said the ZAGGsparq was a failed product since 2009.
Reality: The ZAGGsparq keeps expanding by selling online and going into RadioShack (NYSE:RSH) last quarter as well as AT&T (NYSE:T) this past week. I have to say this is at least a mild success. If it enters Best Buy or Target, then this would be a big success. With a $99 price point, a continued nation wide expansion of this power accessory would be huge to ZAGG. Along with having bought 6 different Invisible Shields, I have bought 2 ZAGGsparqs. They are really good for the iPhone and iPad. It is great for hiking trips or flying on the airplane. It makes me look forward to the ZAGGsparqcase. With rumors on the iPhone 5 being held up last year due to battery technology, I think ZAGG is focusing on the right areas.
Bad myth 2) Citron said iFrogz numbers were going to show bad stuff last summer. The numbers had not been released at the time of the buyout. It was actually understandable at the time although they questioned it weeks after the acquisition was announced. No company would have had the numbers out at that time.
Reality: Since then, full disclosure on iFrogz operations have been made in quarterly filings. In fact, some tax advantages from the acquisition was highlighted. ZAGG was able to depreciate the iFrogz inventory over 4 months (as impacted in the 3rd quarter EPS). ZAGG actually seperates iFrogz revenue out for transparency. We also found out that it takes around 4 months for iFrogz to fully sell through all of its inventory.
Bad myth 3) Like other shorts, Citron said waterproofing technology is a failure. The "Golden Shellback" technology had been bought and up to that time nothing had come to the market.
Reality: (or perhaps TBD to extreme skeptics who don't want to believe CES 2012 media): ZAGG had initially focused efforts on creating a product to sell straight to the consumer. With the cost of the vacuum chamber at $500 thousand dollars, ZAGG decided it was not economical to push HZO that way. They also did not want to void manufacture warranty.
They decided to negotiate with manufacturers to incorporate the HZO technology when devices are assembled. CES 2012 highlighted the interest in HZO. As I have said before, I think deals have already been signed and non-disclosures are holding back announcements. Even the biggest skeptic would have to admit HZO is a game changer for ZAGG after the first deal announcement with a major manufacturer.
Bad myth 4) Citron questioned the cash flow last summer. There were a couple negative cash flow quarters as ZAGG ramped up for the iPad 2. Citron painted a picture of stagnant sales and inventory piling up.
Reality: In order for sales to double each year, ZAGG keeps reinvesting into more product inventory to support SKU expansion. ZAGG has been cash flow positive since silencing the "cash flow" complaint. ZAGG has indicated that it will continue to be cash flow positive.
Bad myth 5) Citron hinted at an imminent PIPE last summer. Citron implied that was the point of the acquisition of iFrogz.
Reality: A PIPE did not happen. Like with most public companies, ZAGG does have an employee stock option plan, which could cause a little share dilution when exercised.
Bad myth 6) Citron took a point from "Worthless Pennies" and insinuated that Best Buy is going decide one day to return all products to ZAGG and stop buying from them.
Reality: This myth has been making its way around the message boards and bear articles a couple years. The relationship with Best Buy remains stronger than ever. Channel checks in Best Buy showed that there was full inventory turnover. Newer packaging on most invisible shield SKUs at Best Buy were displayed in the last quarter. Staples continues to have some of the older SKUs though. Target has entirely new SKUs. Radioshack has some older SKUs only for the iPod nano.
It only took less than 4 months to have complete sell through in iFrogz inventory. Best Buy has recently added the Invisible Shield HD. Best Buy picked up leatherskins, ZAGGwipes, ZAGGfoam, and the Logitech keyboard by ZAGG. Target and other retailers picked up many of these ZAGG products as well. As ZAGG has expanded into most of the cell phone carriers and retailers, this rumor has less impact each month. It is a classic rumor in the true short and distort sense. If this was a biotech company, the rumor would be the FDA is stopping the selling of a certain blockbuster drug and somehow, someway the shorts have knowledge of it.
Overall, "Worthless Pennies" is probably a paid basher of some sort or had a short position that turned sour. This is the type of character probably to be found on clogging up internet message boards all day long. He probably has numerous names. The fears written are always wrong. Roddy Boyd seems to be better, however, besides some company history the major claims are usually wrong as well. His article might have been most effective back in 2008 when ZAGG traded OTC.
Citron is probably the best of them as I think it can do some pretty good research. Some of the Chinese reports have convinced me of its view on companies I know little about. I can't translate Chinese effectively. Seeing a picture of an empty office in China would get me scared. I don't shop there, so how would I know? On ZAGG, the Citron report looks poor in the face of facts. Citron mostly supports the bearish view in a company I now know thoroughly. The Citron article is not balanced in any way as it is extremely biased to the downside. Like with many shorts, it blatently ignores all positives on the company. It turns a blind eye to the bull case. It ignores ZAGG continuing to perform well each and every year as if it never happened. You have to question the motives of any article that has all negatives and no positives or vice versa.
I at least try to address the bear points of view. I am up front in saying I am long the stock. I most recently have been long since the end of December (double bottom reversal signal). All companies have strengths and weaknesses as well as opportunities and threats. If any of you have any real logical bear arguments that I have missed, please post it in the comment section and I will do my best to address it. (It might take a few days to research though).
Citron probably has the most success when it focuses on Chinese companies that Americans have little access to read or dispute information. If this was China, Americans (and mutual fund managers) couldn't walk into the stores and see SKU expansion. They would not use the products. They would not see it on every other iPad. They couldn't tell if people were buying it or not. They couldn't ask what their friends thought about a product. They might not know a major technological revolution is changing the way humans live in a country. Unfortunately for Citron, there is a plethora of information and financial analysis to support the argument that ZAGG is extremely well positioned to take advantage of the mobile revolution.
I hope investors can now separate fact from fiction in regards to ZAGG.
In my next article on ZAGG, I will highlight some exciting developments that I don't think anyone is factoring in yet. I did not have room to mention it in my last article. I will include pictures for those that live in New York City and don't have a chance to actually experience real American retail. Any remaining doubters will witness the competitive advantage that ZAGG has.
Disclosure: I am long ZAGG.