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ZAGG: A Cheap Aggressive Growth Play with Strong Technicals

|Includes: AAPL, ZAGG Inc (ZAGG)
By investing in smartphone stocks like Apple, RIM, Nokia or Google, there will always be the risk of a platform to overcome another, the risk of one system to become obsolete, or the risk of a new fashion tech trend, this threats exists regardless of the expected rise on the Smartphone and Tablet Industry over the long run.

ZAGG is a small company with a market cap of just $190M, and is just another of many trading ideas that can be made around this theme (iPhone, Smartphones, Tablets, and other gadgets).
The companys business model is simple, it designs and produces protection solutions for these gadgets along with specialized accessories.
By searching Google for "iPhone screen protector" the first result is the Invisible Shield, that is nothing less than ZAGGs main product. I found this stock last summer just this way, wanted to buy a screen protector for my iPhone (since the one I bought previously was weak), googled it, ordered it, tried it, and finally considered it to be the best screen protector I ever tried. One thing leads to another and rapidly ZAGG entered my portfolio.

I'll start my comment with Technical Analysis, and my short term chart is annotated as follows:



- Primary Trend: Regardless of a big 40% correction from $10.50 to $6.23 in recent months, ZAGG remains with a very strong primary uptrend, with still enough room to maneuver.

- Downside References: I noted the "potential downside s/t" zone near $ 6.50 which is the current ascending support level, though actually there is always the technical possibility of coming to close a gap slightly below $ 6.00.

- Upside References: Thepotential upside s/tis glossed over the current zone ($ 7.75 -8.10 $), since this area corresponds to the previous historical high (see chart below) and because at the same time this area is also the ema-50, otherwise there is no great reference in this area. Ive posted the "upside II" zone nearby 52 weeks High (~ $10.50) which would be the next upswing target, and Ive also left the noteprojection m/tnext to $14.00 although this is in a different technical context.

- In any case, especially when I look at ZAGG, I like to keep it in context with its medium to long term chart, that I leave here with a few notes:



- From a wider technical perspective, I see last years upward movement that culminated in 2010s high as a general breakout setup, and I look to the recent correction as a regular technical consolidation of such breakout. This interpretation leads me to believe that the next big move would be a further expansion into new highs (the breakout opened the upside with new projections currently in-play), an interpretation supported entirely by my fundamental thoughts on ZAGG.

Regarding ZAGG Fundamentals, the following table includes a brief compilation of various key ratios and the poll regarding estimates for FY11 and FY12:



Without long-term debt, with exponential growth in sales and results, with consistency, with increasing visibility and operating inside a niche market that grows 3 digits annually, ZAGG is by all means an (aggressive) Growth Stock, except in the multiples that is trading right now.
At current prices ZAGG trades with a P/E of 19x FY10, 14X FY11 and 11X FY12, taking in consideration an average annual growth (CAGR) 2008-12E of 59%, would not be surprising to see a company like ZAGG trading at double or triple the current multiples, literally trading at 2 or 3 times the current market levels.
ZAGG is literally a growth stock listed as if it was a value stock, which is curious in a market like the NASDAQ where stocks of this type typically trades with its P/E at least close to its CAGR.

Evolution of sales and quarterly net income is as follows:



The past quarter represented a new record on sales and despite 4Q net income was slightly lower than 3Q, both items were above the most optimistic estimates. Above all, and being ZAGG a side bet on the smartphoness niche (and tablets, gadgets, etc), the evolution of sales and net income reflects a strong correlation between the success and growth of the smartphone industry and gadgets, making ZAGG a pure play for this niche (as long as Smartphones and Gadgets keep growing, its expected to see ZAGG delivering consistent growth as well).

The following chart includes historical sales and net income along with the current poll estimates for the next 2 years:



A common question many investors are doing right now is:

- If ZAGG has been showing strong results quarter after quarter and it operates inside a strong growth niche, why the stock fallen so much in recent months?

I think the answer is linked with several points:

- The market is not perfect, and is full of examples of prices too expensive or too cheap, in fact if this wasn't like that it would be very difficult to trade the market and find investment opportunities.

- ZAGG is still a relatively small company ($190M market cap), this has impact in terms of visibility and volatility in the face of events related to their activity.

- There is a big short exposure on ZAGG, corresponding to about 35% of its own float, this may explain some of the exaggerated moves on the downside, but simultaneously this is also a strong Bullish catalyst (the higher the short ratio, the greater the impact of short covering when it happens). Big Short exposure in ZAGG is not something new, apparently for more than a year that many investors decided to take the view that ZAGG will not succeed, so they are betting against ZAGG. I assume that the strong upward movement since 2010s makes much of this short exposure into a big global losing position, secondly, ZAGG has been delivering results quarter after quarter that do not corroborate the bearish fundamental thesis at all.

- And finally and more important, there is a wrong empirical notion followed by many small investors, that the investment thesis in ZAGG is fully associated with Apple and it's gadgets (iPhone, iPod, iPad), when
in fact this investment  thesis should be linked to the Global Gadgets in general, Smartphones and Tablets, not necessarily just iPhones and iPads.

The -30% one day drop in ZAGG stock registered last month (March 2nd) corresponds to three quarters of the total correction, it happened in the same day Apple presented the new iPad2, in that event besides from introducing the new iPad, Apple also announced its new Smart Cover:



The announcement of this simple accessory for Apple's iPad2, was enough to drag the price of ZAGG from $9.30 the day before to a $6.68 intraday low... And Why?
Because empirically (and in the heat of the moment) many investors thought that this enhancement simply would turn ZAGG's products obsolete (specifically iPads InvisibleShield and Zaggmate), that happened inside a context of strong short pressure in the market (and financial forums)...

However, looking coldly it doesn't make them obsolete, quite the contrary. Notice that most of the damage done to the screen of an iPad (or any gadget) happens exactly when they are being used, by other words when the Smartcover is not protecting it, so the InvisibleShield is still needed for its purposes, on the other hand ZaggMate is much more than just a protective device, without even considering that sales specifically for iPad still represents only a small fraction of total turnover of ZAGG. Having said that, the market reaction to this event was much more related to crowd psychology rather than fundamentals.

The future growth of Media Tablets on a global scale is still unknown since it just started with the iPad one year ago, the only certainty is that will grow insanely in coming years. According to a report from Gartner the projected unit sales until 2014 is the following:



In 2010 almost all the tablets sold were iPads, but a lot of tech players are jumping into the segment, 2011 will still be one year completely dominated by Apple in this segment, but gradually it is expected the following trend in market share:



As with many products, the first player starts with the largest market share, it remains as leader, and despite from keep growing at a fast pace, many new players will eventually gain a significant share.

And what does this mean for ZAGG on its Tablet Segment products?
It means that despite from being much more focused on the iPad right now (it couldn't be other way), in the mid term their revenues stream on the Tablet front will most likely come from a diversified variety of Tablets (not iPad dependent).

The same rationale can be done about the Smartphone segment, i.e., despite selling much more accessories for iPhone in the present, its potential clients go far beyond the owners of iPhones, and right now the Smartphone segment is divided as follows (based in 4Q09-4Q10 data):



In the global Smartphones segment, Apple does not even represent the dominant brand in overall terms (though Google itself includes dozens of different manufacturers in this chart). In my view, the fact that ZAGG still makes most of its sales from iPhone accessories, is not a vulnerability, quite the opposite I believe its an opportunity not yet priced in (the penetration on non-Apple devices will greatly increase their implicit growth potential and therefore its estimates).

And where I am going with this?
I just want to refute the point that ZAGG is not a specific play on Apples iPhone or iPad, obviously these two products represent today a very significant slice of its target, but in the medium term this sales target will tend to dilute in a much larger variety of products and brands, and this will happen in a context of exponential growth of Smartphones and Tablets in general, moreover ZAGG is already positioned for this scenario as it already produces protective equipment for many brands, models and types of gadgets as you can see here.

Apple invented the SmartCover for iPad as will most likely invent any other accessory for the iPhone, in the past Apple did exactly the same because that's what they do, and it was in this exact context that ZAGG was born and thrive. Within this context of love/hate Apple on ZAGGs thesis, somebody asked me the other day:

«What If Apple decides to start selling screen protectors with the same quality of ZAGGs InvisibleShield

Regarding Screen Protecting, ZAGG has plenty of competitors, although it is almost consensual in most reviews that if you want the highest quality protection for your screen you chose ZAGG. Apple entering this niche is at least questionable, but if it happens it would probably mean good news for ZAGGs shareholders... I mean, for a $312B Giant like Apple the simplest step to do this, would be to just buy ZAGG, which is a tiny little $190M company with no debt, very profitable, dedicated tohigh-end premiumproducts (much like Apple itself) and with patented technology. Anyway, I don't own ZAGG expecting it to be a potential acquisition by Apple, I own ZAGG because I believe its and "aggressive growth" play at an interesting price.

End notes:
Regardless any short term movements that may occur (for example it would not surprise me to watch another retest to recent lows) Im essentially focused on the mid-long term perspective, and in this context I see implicit potential for ZAGG to trade at 2 to 3 times its current levels somewhere during this Smartphone/Tablet exponential growth phase (which could last 3-4 years).

PS: I'm sorry for my English but it's not my native language ;)


Disclosure: I am long ZAGG.