Skullcandy (SKUL) Memo Company Description SKUL is a selfdescribed “original performance and youth culture audio brand.” The company is a designer, marketer and distributor of performance audio and gaming headphones and other accessory related products under the Skullcandy, Astro Gaming and 2XL by Skullcandy brands. The firm targets a specific, niche customer: those that embody the “collision of the music, fashion and action sports lifestyles.” The Company's products are sold and distributed through a variety of channels in the United States and approximately 80 countries worldwide. The Company is engaged in the distribution of headphones in specialty retailers focused on action sports and the youth lifestyle, such as Zumiez, Tilly’s and hundreds of independent snow, skate and surf retailers. It distributes through consumer electronics, mass, sporting goods and mobile phone retailers, such as Best Buy, Target, Dick’s Sporting Goods and AT&T Wireless. Skullcandy products are also sold through its Website. (Google Finance with my own additions and revisions). SKUL is a compelling short I) SKUL is a bad business 1. SKUL is simply not “in” anymore a. SKUL’s general target market does not even like them: Skulcandy’s relevance on Google Trends has declined 71% since 2011. Piper Jaffray just announced the results of a very conclusive study: 56% of teens plan to purchase headphones in the next six months. However, when teens ranked their favorite brands… 46.1% of respondents chose Beats by Dre, 25.3% chose Apple and only 9.8% chose Skullcandy. Piper Jaffray reports that Skullcandy’s brand relevance is down 31% in just two years. When compared to its competitors, SKUL has clearly lost the headphone battle. Consider the graph below illustrating the relevance of “Beats by Dre” audio products (red), the “headphone space” in general (yellow), and SKU (Blue). Name: Max Katzenstein Phone #: 2143106446 College/School: McIntire Year: 3rd
Transcript
Skullcandy (SKUL) Memo
Company Description SKUL is a self-‐described “original performance and youth culture audio brand.” The company is a designer, marketer and distributor of performance audio and gaming headphones and other accessory related products under the Skullcandy, Astro Gaming and 2XL by Skullcandy brands. The firm targets a specific, niche customer: those that embody the “collision of the music, fashion and action sports lifestyles.” The Company's products are sold and distributed through a variety of channels in the United States and approximately 80 countries worldwide. The Company is engaged in the distribution of headphones in specialty retailers focused on action sports and the youth lifestyle, such as Zumiez, Tilly’s and hundreds of independent snow, skate and surf retailers. It distributes through consumer electronics, mass, sporting goods and mobile phone retailers, such as Best Buy, Target, Dick’s Sporting Goods and AT&T Wireless. Skullcandy products are also sold through its Website. (Google Finance with my own additions and revisions).
SKUL is a compelling short I) SKUL is a bad business
1. SKUL is simply not “in” anymore a. SKUL’s general target market does not even like them:
Skulcandy’s relevance on Google Trends has declined 71% since 2011.
Piper Jaffray just announced the results of a very conclusive study: 56% of teens plan to purchase headphones in the next six months. However, when teens ranked their favorite brands… 46.1% of respondents chose Beats by Dre, 25.3% chose Apple and only 9.8% chose Skullcandy. Piper Jaffray reports that Skullcandy’s brand relevance is down 31% in just two years. When compared to its competitors, SKUL has clearly lost the headphone battle. Consider the graph below illustrating the relevance of “Beats by Dre” audio products (red), the “headphone space” in general (yellow), and SKU (Blue).
Name: Max Katzenstein Phone #: 214-‐310-‐6446 College/School: McIntire Year: 3rd
Skullcandy (SKUL) Memo b. SKUL’s very specific, niche market is shrinking
Skullcandy targets the “extreme sports” lover. The relevance of “extreme sports” has declined 77% since 2004 according to Google Trends.
2. SKUL seemingly produces only the crappiest of products List Rank
Techradar Not rated Top Brands and Products Not rated Headphone.com Not rated Forbes 10th Appliance Retailer Not rated The Wirecutter 9th Sound and Vision Not rated CNet Not rated Inner Fidelity Not rated Best of Luxury Not rated Stereo Headphone Reviews 10th Ask Men Not rated Headphones Reviewed 67th Stuff.TV Not rated Test Freaks 24th Amazon 23rd
3. Retailers discount SKUL products on a regular basis:
Product Picture Skullcandy Other Retailer Aviator
$149.99 Best Buy: $119.00 Amazon: $77.00
Hesh 2
$59.99 Best Buy: $56.99 Amazon: 49.95
Navigator
$99.99 Best Buy: $79.99 Amazon: $49.99
Skullcandy (SKUL) Memo SLYR
$79.99 Best Buy: $59.99 Amazon: $59.99
II) Though I think that SKUL is a bad business, the market thinks that it is a good business
1. The market expects significant future cash flow a. SKUL’s stock is up 56% YTD
2. SKUL is by definition a “growth stock”
a. A value stock is defined as one that investors buy do to the cash flows of current projects b. A growth stock is defined as one that investors buy do to the promise of cash flows from future or
developing projects c. SKUL’s current projects (e.g. all of their current products) do not produce positive cash flow d. Thus, by definition SKUL must be a growth stock valued on expected future cash flows from future
projects a. SKUL’s value must be derived from expected future cash flows of future projects
3. This allows for the possibility of market misperceptions!
III) SKUL’s future products will not generate the cash flow that the market expects
(So, let us take a look at SKUL’s possible cash-‐generating future projects)
1. Market Misperception: SKUL’s current products aren’t so bad! a. Reality: SKUL will continue to sell crappy headphones that customers do not want
i. Let’s look at the cool products they have in the pipeline:
“Headphone”
“Headphone”
“Headset”
“Headphone”
Skullcandy (SKUL) Memo
2. Market Misperception: SKUL has a cool new women’s line! a. Reality: Women do not want to buy them
Scullcandy released their women’s line a week ago and people are apparently going crazy… Actually, a Google Trends search for “Skullcandy Women” and all other iterations revealed zero searches since the announcement:
3. Market Misperception: But SKUL just bought Astro Gaming! a. Reality: The market values Astro’s acquisition much too highly; unrealistic growth expectations for
the gaming segment fuel SKUL’s overvaluation i. Published expectations of more than 50% for the gaming headphone segment is extremely
unrealistic ii. 2013 gaming growth was artificially inflated with the introduction of several new products
Astro’s popularity has soared since the acquisition, but will it deliver cash flow necessary to justify SKUL’s stock price?
b. Reality: The Astro Gaming segment is actually extremely tiny i. Consider that SKUL acquired Astro for only $10.8 million in 2011 ii. Consider that Asto’s revenues were only $9.6 million in 2010 iii. Even if Astro had been growing at a 50% CAGR (an extremely high estimate), this would
represent only 15% of SKUL’s total revenues for 2013.
4. Market Misperception 4: SKUL’s cash flow decline in recent years is due to artificially high margins due to one-‐time expenses.
a. Reality: Though legal, acquisition, and other one-‐time expenses have increased expenses, most of SKUL’s margin deflation is due to structural changes within the company, such as attempts to stifle brand erosion through marketing, rolling out more products per year, etc.
b. Reality: It is unlikely that EBITDA margins will return to pre-‐2013 levels. My models conservatively allow them to rise to 10%, when in fact they were -‐2% in 2013.
Skullcandy (SKUL) Memo IV) SKUL is overvalued
1. SKULL is a bad business 2. The market thinks that SKUL is a good business
Discounted Cash Flow Valuation
Assumptions: Conservative tax rate compared to historical ETR WACC of 9.67% DD&A, Change in NWC, and Capex as percentage of sales Results: Worst (An extremely unrealistic) Case: Revenues grow at 10%, shrinking margins stay constant
EV/EBITDA Valuation SKUL trades at 11.7x 2014 EBITDA Industry peers trade at 8.95x 2014 EBITDA Worst Case: SKUL trades above industry peers at 11x
Price Target: $7.85 (7% upside) Base Case: SKUL trades in line with peers at 9x
Price Target: $6.14 (27% upside) Best Case: SKUL trades below peers because it is a worse business
Target Price: $5.35 (36% upside) Catalysts
• 2014, Q1 earnings disappoint • “2014 Women’s Collection” is indeed ineffective • Continued deflation of multiples in the tech space • Increased financial press
Risks
• High-‐Beta stock is supported by bull market • “2014 Women’s Collection” is a huge success • Possible Short-‐squeeze • New product offerings • Drastic change in consumer preferences/consumption habits • Astro Gaming segment breaks 50% YOY growth • SGA can be significantly cut • The beginning of a serious turnaround/restructuring • Acquisition target
