iROBOT: Too Obvious A Macro-Trend

| About: iRobot Corporation (IRBT)

Of all the stories I've come across in researching articles for this blog, this might be my favorite, or at least the most fascinating. Today we'll be talking robots. Rock 'em. Sock 'em. Robots. Yup, robots!

Founded by "roboticists" from MIT, iRobot Corp. (NASDAQ:IRBT) operates on the cutting edge of technology. iRobot's robotic offerings are targeted towards providing solutions to problems that are too "dirty, dull or dangerous" for humans to happily resolve. In the future, robots may battle mankind for control of the earth, but for now they're happy enough to do our vacuuming and mopping.

According to the company, its robotic offerings will in time extend to a "broad array of markets such as law enforcement, homeland security, commercial cleaning, elderly care, oil services, home automation, landscaping, agriculture and construction." However, currently their products fall into two categories: military and household.

iRobot's marketing expenditures increased in the first nine months of 2007 by 50% to a little over $30 million, while R%D, obviously the key component to the company's future success, received a 19% bump to $13.1 million. Sales results somewhat disappointed the street. Total revenue increased by 16% on a year over year basis, however inventory increased by over 100% to $41 million in finished goods.

The household market accounted for approximately 53% of iRobot's revenue in the nine months ending Sept. 2007 with the government and industrial market making up the remainder. This is perhaps less worrisome moving forward than it might appear. Should the purchasing power of American consumers recede, which it seems likely it will, it is possible that military spending, which increased 39% in the first nine months of '07, can sustain the company until the American consumer rebounds (whenever that might be).

However, the troubling aspect lies in the valuation respective to earnings. First of all, there's no consensus on earnings at the moment. The four analysts with fourth quarter predictions are all over the map. The low estimate calls for $0.24 and the high estimate $0.53. The average, $0.42, is $0.50 higher than the loss of $0.08 that the company reported in the fourth quarter of 2006.

For arguments sake, let's say that company meets the average expectation and delivers 42 cents for the quarter and a nickel for the year. That would be a pretty darn good quarter, right? Well, yes and no.

Expectations for this most extraordinary story (stock) are immense because it IS a great story. Who wouldn't want to participate in the robot boom that's sure to happen in the 21st century? Judging from the current valuation, everybody. And unfortunately, that's the problem.

Going back to our predictive fourth quarter report, let's assume that the company meets. In that instance, the multiple for the trailing twelve months, assuming a fairly static share price, checks in at 360 with the forward multiple at 58. And to achieve the forward multiple, the company would have to increase earnings by 600% to arrive at the estimate. While this is achievable, the current price doesn't leave much room for price appreciation.

I am not arguing that it's not a great story because it is. It's the kind of macro-trend I like to get behind. The problem is that it's an obvious macro-trend. It's already been bid up. Like a train at the station everyone jumped on board the moment the car arrived at the platform. Where's the upside?

It's more likely, at this juncture, that several folks will need to evacuate the investment, bringing IRBT down to a more reasonable level before the train can again leave the station.

Disclosure: I do not own shares in any of the companies mentioned.