Skullcandy: The Shorts' Unfettered Greed And The Regulatory Environment That Breeds It

| About: Skullcandy (SKUL)

Skullcandy (NASDAQ:SKUL) represents what is wrong with today's stock market. We have reached a point where the stock market is no longer about helping growth companies succeed, create jobs and wealth. It's now win at all cost regardless of the rules. How could a company successfully creating a unique brand, with a 3 year EPS growth rate of 48%, and trading at 14 times earnings, attract a short interest of 81.94% of the float. This equals 45% of all outstanding shares. The original concept of shorting stocks in order to self-regulate the stock market is an absolute joke when you actively follow the abusive actions of today's professional shorts. The following article by Matt Talibi in the Rolling Stones Magazine gives quite a portrait of how the shorts on Wall Street operate and how the brokerage firms cooperate and help them. I for one, have no illusion that exposing this dark side to the market will improve the regulatory environment, but if I can help create an informed shareholder base in Skullcandy that doesn't panic when the shorts create chaos, I just might enjoy the self-satisfaction of watching them lose a couple hundred million dollars. That lesson alone will do more than all the regulators could.

Today's Most Shorted Stock on NASDAQ

Skullcandy is a lifestyle products company selling distinct audio branded headphones and other smart phone accessories. Skullcandy brings color, character, and performance to what has been a monochromatic space. They co-brand products with the NBA and other sporting venues. They also recently announced a line that links with runway model Kate Upton. While the shorts have made a point of dismissing the value of a developing brand, I suggest they study history, lick their wounds and find another fad to dismiss. Mistakes this big are hard to fathom. Here are the reasons why Skullcandy is a trend, not a fad.

Net sales in the second quarter of 2012 increased 38.2% to $72.4 million from $52.4 million in the same quarter of the prior year. In the second quarter of 2012, domestic net sales increased 34.1% to $50.6 million, international net sales increased 59.9% to $16.5 million and online net sales increased 22.8% to $5.3 million.
 Gross profit in the second quarter of 2012 increased 33.1% to $35.7 million from $26.8 million in the same quarter of the prior year. Gross profit as a percentage of net sales, or gross margin, was 49.2% in the second quarter of 2012 compared to 51.1% in the second quarter of 2011. The decrease in gross margin is mostly due to a shift in sales mix to higher price point products with lower gross margin structures.

  • Skullcandy has historically great 3rd and 4th quarters.
  • Skullcandy is followed by 11 analysts all having buy recommendations with a consensus price per share estimate of $22 and a high of $33.
  • The last three years' revenue was $118 million, $160.5 million, $232.4 million, and projected revenues for 2012 are $280 million.
  • The CFO recently purchased $250,000 dollars of stock in the open market.
  • Skullcandy has beaten the consensus earnings estimate in the 5 quarters they have been public.
  • Earnings were $1.00 per share in 2011 and are projected between $1.15 to $1.20 in 2012. Earnings are projected at $1.43 in 2013.
  • The PEG ratio for SKUL is 0.67.
  • Astro Gaming just launched the A 50 wireless headset to strong reviews.
  • For more information on SKUL.

The over 100 Club

Here are a couple of companies that now have a institutional hold of over 100% of the outstanding shares. The long term shareholders have been rewarded handsomely by knowing the fundamentals of these companies would eventually destroy the rational for shorting them.

Digital Reality Trust (NYSE:DLR) owns, acquires, develop, redevelop and manage technology-related real estate. They target high-quality, strategically located properties containing applications and operations critical to the day-to-day operations of technology industry tenants and corporate enterprise data center users.

• DLR has 122 million shares outstanding. The institutional hold is 136.2 million shares and insiders own approximately 0.1 million. Here is more information on Digital Rality Trust.

• More information on Digital Reality Trust.

Advanced Data Systems (ADS) is a leading provider of data-driven and transaction-based marketing and customer loyalty solutions. The company offers a comprehensive portfolio of integrated outsourced marketing solutions.

• ADS has 50 million share outstanding. The institutions hold is 66.1 million. The insiders own approximately 600K shares.

More information on Advanced Data Systems.

Lululemon Athletica (NASDAQ:LULU) is a sports clothing brand that specializes in yoga clothing. The shorts failed to grasp how large the yoga market would become. The upscale demographics of the yoga clothing buyer destroyed the rationale for shorting this stock. To this day, shorts are still wondering who is buying these $60 t-shirts. Lululemon has branched into selling other product lines, and has become the highly valued brand it is today. With a current institutional hold of 93% and a short interest of approximately 11% of the float, LULU has been in a perpetual squeeze for years.

  • LULU has 112 million shares outstanding. The institutional hold is 112 million. The insiders own approximately 11.2 million shares.
  • More information on Lululemon Athletica.

Kamikaze in Action

In the second quarter, as 14 of the top 15 fund holders were buying more stock or holding their positions, the professional shorts were busy selling another 25% of the company they don't own. Clearly with these shorts willing to short 81.94% of the float, we are looking at the potential for a historical short squeeze. The last reported institutional holdings of 21.174 million shares and the insider holdings of 10.1 million shares add up to 31.274 million shares in a company having only 26.5 million shares outstanding. There are only 5 million shares not held by institutions, and the declared short position is 11.7 million shares. With Skullcandy projected to make $0.87 in the next two quarters, and sitting right at the breakout price, I say grab your popcorn and get ready for the roller coaster ride.

Disclosure: I am long SKUL, LULU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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