Before Crocs (CROX) and Heelys (HLYS) saw their stocks implode in late 2007, analysts had fallen asleep at the wheel. While the shorts had already figured out how inventory would build and estimates and price targets would all need to be cut dramatically on both companies, almost all of the analysts following CROX and HLYS simply based their estimates on the guidance being offered by these companies. Needless to say, we all know how these stories played out so quickly and dramatically to the downside.
This leads us to Skullcandy (SKUL). Although shorts have covered some of their position, 38% of the total outstanding share count is held short. Even with the stock 40% off of its highs, they are not covering in droves. This tells us a lot. They see lower prices ahead and we think the shorts are going to be right.
Price pressure has begun to build in the channel. Target (TGT) recently lowered the prices of the company's Ink'd product to $16.99 from $19.99, while RadioShack (RSH) has begun to offer 30% discounts on Skullcandy products. This is a toxic mix for any company with a consumer bent. With prices being lowered on their products, this suggests that excess inventory is being built up in the channel. Excess inventory ultimately means lower profit margins and could eventually lead to no profit at all.
After enjoying a first mover advantage for the past few years, a number of new entrants have been moving into the headphone/earbud space recently. While Dr. Dre continues to gain share, Sony (SNE), Panasonic (PC), Motorola, and Sennheiser have all flooded the markets with their respective offerings. To understand how dogged the competition is, investors who are long Skullcandy should take a few minutes to view the various offerings on Amazon.
While the market for headphones and earbuds has taken off with the proliferation of smartphones, how much room is there for a company such as Skullcandy to differentiate itself from other competitive offerings? Without a proprietary and differentiated technology offering that sets it head and shoulders above competition, we feel that Skullcandy's current market share is going to be eaten into by the various new offerings that have flooded the market.
If we are right in our assessment, we feel that the current estimates for 2013 are way too high. The shorts know this and this is why most of them have held onto their short positions ahead of earnings shortly. Excess inventory in the channel is only going to build further from here. This is why prices are being cut. There are too many products out there and not enough demand for the products, a deadly combination.
Although we are not sure of the timing of a new down-leg for the stock, we feel confident that the company's negative inflection point has arrived from a fundamental perspective. While we are not short the stock, if our broker could find a borrow, we would certainly short it at current prices. We feel that an eventual move to $6-$7 is in the cards as the current estimates for 2013 get cut and move a lot lower.