|Shares Out. (in M):||24||P/E||25.0x||21.0x|
|Market Cap (in $M):||234||P/FCF||NM||NM|
|Net Debt (in $M):||-6||EBIT||0||0|
Readers can take a look at the previous write-up on VIC by Lukai on 7/26/10 for an overview of the company, although this report is going to present a quite different thesis. This is a recommendation to short ZAGG stock or buy May 2011 exp puts.
I would like to introduce you to a very overhyped fad stock run by a management team with a shady history of penny stock promotion. The company is called ZAGG Inc. (ZAGG). Their main business, which accounts for over 95% of their sales, is selling screen protectors for smartphones and tablet computers. The stock has appreciated 280% in the last 6 months driven by a big jump in Q3 2010 results and by being seen by day traders as an iPad trade. I could have made an impressive argument for shorting ZAGG just based off valuation and the competitive dynamics of the screen protector industry. I would have first pointed out that ZAGG trades at an astronomical trailing P/E of 33x and a forward P/E based over 20x (based on highly questionable earnings). The stock also trades at almost 4 times sales. I would have pointed out competitors selling 5-packs of screen protectors for $1.38 (here). I would have also pointed out that the huge growth in Corning’s Gorilla Glass renders all screen protectors obsolete as consumers catch on to the fact that they are unnecessary. It would have convinced you that ZAGG’s stock is going to die a slow death, that forward earnings estimates were way too high and that the valuation was destined to come back down to earth.
We could have made all those arguments but there is a much better reason for you to short ZAGG and that is that the company is a complete scam. All the signs are there if you take the time to dig beneath the surface. The company has a history with shady stock promoters that were banned by FINRA, the SEC and the OCC. These banned individuals were involved in funneling millions of dollars out of ZAGG. We uncovered these facts when we hired a private investigator to do thorough background checks on all the senior executives at ZAGG. We also uncovered that ZAGG’s CFO, Brandon O’Brien, while VP of Finance at Fonix, was in charge of due diligence on a $33 million acquisition that is now being targeted by the SEC for being a fraud. We have made a copy of the due diligence report available to the public and a link can be found here. It is an incredible read.
Just one example of ZAGG’s tabloid history is a press release in which ZAGG touted a “Leading Canadian Wireless Distributor to Carry invisibleSHIELD” and went on to claim that the distributor, Z-Tech had “strong national retail channels such as Bell, Rogers, Telus, Fido, Solo, Koodo and Virgin Mobile.” When we did a background check on Z-Tech we found out that the company had just been founded a month before this press release and that the President of Z-Tech, Scott Wicks, previous experience was working at a copy shop.
ZAGG’s management is quick to brag about their relationship with Best Buy every chance they get, making wildly promotional statements that on at least one occasion almost got them kicked out of the retailer. Management has routinely claimed that Best Buy was only getting keystone markup (100%), or $12-15 per shield only to have the story proven wrong by some savvy analysts that found out that Best Buy employees using their cost-plus employee pricing could buy the product for less than half that price. When caught in the lie management admitted they actually get only $6 per shield. Miraculously, management made no adjustment to reported gross margin despite the “price cut” from $12 to $6.
ZAGG management has also been dogged by claims that Best Buy and the other wholesale channel merchants’ contracts all contain buy-back clauses, both written and implicit, which would make ZAGG’s sales recognition when product is shipped to Best Buy improper and a channel stuffing scam. ZAGG’s CFO adamantly stated that Best Buy had no right of return in a quarterly conference call only to be forced to revise his remarks in an 8k (link here) on Nov. 30 admitting “Best Buy can return products to the company under limited circumstances, including where products are defective or other similar customary reason.” Those customary reasons are certain to include whenever there is too much inventory in the channel according to interviews we conducted during our extensive due diligence. ZAGG will be forced to give Best Buy a credit to their accounts payable to ZAGG for all of the millions of dollars worth of excess Christmas and other obsolete inventory (Palm Pre shields!) recently returned that is now being auctioned for pennies on the dollar at sites like liquidation.com. Just go there and see it for yourself.
As with most scams, ZAGG claims it has been profitable for over 2 years but has only ever burned cash (consistently large disconnect between FCF and reported earnings). All of the supposed earnings piled up in Accounts Receivable and Inventory. Accounts Receivable is hugely overstated because of the massive phony channel stuff with ZAGG now being forced to buy back millions of unsold inventory thus taking charges to A/R’s that will wipe out a major chunk of all accumulated earnings. Incredibly, despite the Q3 channel stuffing Inventory just keeps going up. Management has even been warning analysts that Inventory will stay elevated at year-end, which is utter nonsense, as the inventory not sold during the holiday season is either being liquidated on liquidation.com or should be written down. Keep in mind Q1 is by far their weakest quarter of the year and cell phones go out of style every six months. We have tried to get the company to let us inspect this “phantom” inventory only to get the reply that their inventory actually resides in a 3rd party fulfillment center not open to the public. We are certain that at least 80% of the stated inventory of over $12 million does not exist. ZAGG has been dramatically understating their Cost of Goods to report phony profit margins combined with sales channel stuffing to report earnings that simply don’t exist. The future holds a combination of A/R and Inventory write-downs that are certain to wipe out almost every dollar of “profit” that ZAGG ever reported.
One might think that this type of scam would be impossible to pull off; that the auditor Hansen Barnett & Maxwell (HB&M) would catch it and not allow it to happen. HB&M is a small Salt Lake City auditor ZAGG’s used for years since its RTO and was found to have audit deficiencies in its previous inspection by PCAOB. Incredibly, just 3 weeks into the new year in the middle of the crucial audit process and after the key year-end inventory count, ZAGG dismissed HB&M and made a hasty decision to risk upgrading to “big four” auditor KPMG. This desperate move, after presumably failing its HB&M audit, might be the first sign that ZAGG management is ready to start coming clean and is ready to take a “big bath” to pass muster with KPMG. We’re certain that ZAGG will not pass a KPMG audit any other way. KPMG might even quickly resign out of frustration with the mess at ZAGG. Plus KPMG will surely decide they need to go back and re-audit the last two years, which will undoubtedly significantly delay filing of final audited financials, perhaps forever. If they are ever able to pass the audit, it is certain that most if not all of ZAGG’s previously report earnings will be wiped out. With any of these scenarios happening, we believe the stock is destined to fall back to the $2-$3 range.
Catalysts: Further auditor resignation, Failure to file 10K on time, restatement of prior earnings
Risk: The largely retail investor base continues to ignore the red flags, chasing anything remotely tied to Apple which might prolong the disconnect between the stock price and reality.
|Entry||02/04/2011 09:34 AM|
How can you short a company that has MC Hammer promote a product on Oprah??
But seriously, why May over August? May $5 puts look to be about $0.25, but they seem to have a high likelyhood of a 100% loss to me.
|Subject||RE: RE: RE: scams|
|Entry||02/05/2011 08:13 AM|
Can somebody please get Mitt Romney on the line? Joseph Smith would be proud.
|Subject||Most compelling short ever? except...|
|Entry||02/17/2011 10:19 PM|
I keep digging into this and except for some reasons at the end (and maybe more) it's looking like one of the most compelling shorts I've ever seen (that said I'm relatively new to shorting but have spend way too much time - thank you China - looking at fraudulent accounting this last year).
So in order of credit / benefit of the doubt given to the company:
-It's at 30X reported earnings thanks to obvious mo-mo sponsorship, so not cheap to begin with, they're growing, but...
-Their primary product (screen cover) clearly has less value now vs a year ago pre-Gorrilla Glass.
-Mgmt backgrounds wouldn't seem to indicate a track record of adapting companies to changing circumstances, Netflix style (short =ugh...), but rather just nosediving.
-Their inventory turns have gone from 6x/year in 2009 down to 2x/year last Q so:
---At a minimum they are terrible at inventory managment (which is not THAT hard, so implies other cockroaches)
---Almost certainly they will need to write down a lot of inventory with the new audit and along with it their old profits (to zero)
---Seems even more likely there is outright fraud and the inventory just isn't there and SEC investigation occurs...
So worst case (to a short) is that you are shorting an overvalued growing business with inventory-inept management in a longer term dying business.
The only "excepts" are:
-Why haven't the insiders sold even more shares, given the imminecy of the exposee from KPMG?
-Will the retailers like Best Buy be able to sell enough of their overpriced products because they capture so much margin on each sale (extended warranty style)?
|Subject||RE: Most compelling short ever? except...|
|Entry||02/18/2011 04:43 AM|
I'd like to suggest another "except" to the bearish case - not that I am bullish on the company, I'm just saying there is another risk factor.
In the 1990s I made a lot of money with a similar company, now defunct, called Recoton, a more than 20 bagger from 1990 to 1994, and ultimately even higher in 1998. You can still pull up charts, news and data on it on Bloomberg under RCOTQ. Like Zagg it also had a line of minor accessories, the kind of stuff you could buy in Radio Shack, and I don't think they offered anything special in terms of proprietary technology or value.
But one thing the company was good at was building its relationship with customers, the biggest of which were Circuit City (bigger than Best Buy at the time) and Best Buy. These chains started out buying just a few things from RCOT and then discovered it was easy to order more and more things from one source and have just one truck pull up at a store every day with new inventory, not ten trucks from ten different vendors. RCOT acquired numerous brand names in speakers, antennas, and other gizmos and distributed them all, with the customers happy to get them all from one place. One of the things they liked is that if they overbought on product X, RCOT would let them return it and get a credit they could use to buy more of product Y; smaller suppliers lacked the broad enough line to make that option attractive. And, if I recall, sometimes you would see big jumps in inventory which would be a prelude not to trouble but to a big jump in sales the next quarter.
You may be right in everything you say about Zagg's product line, but if BBY feels it is getting especially good service from them and wants to add more products, the short isn't going to work until BBY stops growing the line. Again, I have no reason to think BBY loves Zagg over other vendors, just that it is something you should try to check.
|Subject||RE: RE: Most compelling short ever? except...|
|Entry||02/18/2011 10:53 AM|
Actually a big part of the thesis is that the number of SKUs at Best Buy has decreased in the last few months, they stopped carrying their "full body" shields - which include little film strips for the sides and back of the phone and now only carry the screen shield (which is what everyone else makes too). I've heard this from other investigators and also from checking the website the full body shields aren't in stock anymore...
|Subject||RE: RE: seeking alpha|
|Entry||02/18/2011 10:56 AM|
hxf82, great writeup. Could you comment on the heated exchange in the seeking alpha link posted by vfm343?
The invisibleShield product does seem to be losing relevance; however, I have seen some of ZAGG's other products and they aren't half bad (e.g. ZaggMate - http://www.zagg.com/accessories/zaggmate-ipad-case). Also, the deteriorating metrics in A/R and inventory are definitely a red flag, but they could potentially be consistent with a fast growing company where volumes are exploding, no? I can't argue with the inventory stuffing or obsolescence claims (which is the heart of the short thesis), and clearly the management history is a good indicator that you are spot on in identifying a potential terminal short. I guess my only concern is that they have diversified their product base and the investments in working capital and ballooning inventory have been in other categories that might end up having descent margins / sell-throughs?
Just playing devils advocate here. Without question very interesting writeup. Congrats.
|Entry||03/02/2011 01:38 PM|
Apparently introducing their own covers. Ouch.
|Entry||03/02/2011 02:12 PM|
When you're a serf in someone else's ecosystem, you run the risk of the lord coming out one day and banishing you from the land.
Nice call on this one hxf.
|Entry||03/02/2011 02:24 PM|
How big is APPL covers for ZAGG?
|Subject||RE: RE: AAPL|
|Entry||03/02/2011 03:22 PM|
I didn't even expect this - the design by apple is pretty clever...
This seems like the beginning of capitulation - this must be an event to shake the momo sponsorship out and kills a lot of the growth story even aside from likely inventory write down. Seems like worth $5 maybe with accurate accouting, $1-2 if hxf is right about the inventory overstatement and KPMG kicks them in 2 weeks.
|Subject||RE: Covered 1/3 of the position here|
|Entry||03/10/2011 04:10 PM|
This is a fascinating one. I don't have a dog in this fight right now but I am going to the Roth conference next week and have a meeting with them on Wednesday morning. Would they show their face at a conference after dropping a bombshell on Monday or do you think this is a sign they think the fourth quarter is fine and KPMG is not going to raise a fuss? I guess they could always cancel at the last minute.
|Subject||Strange after hours|
|Entry||03/15/2011 12:21 AM|
This was really strange after hours, with the stock down as much as 20% before the cc...
-They first announced at 4:30 that their audit chair left and was replaced by some other director not saying why.
-Then they delayed their CC from 5pm to 6pm supposedly because of technical difficulties.
-Then on the call they say "we're grateful to kpmg and etc for getting these AUDITED financials done" where the press release with results at 5:45 clearly says they are UNaudited and they are not finished and due by March 31 and it could change, which is ALSO not true because they file as an accelerated filer which means they are due by March 15
- They described the director resignation/replacement as this weird related party thing that made no sense to me: supposedly a product they were making "Zaggbox" was doing business with some related party the director owned so they took the unit and sort of spun it off so the director owns the entire unit and the company is left with an interest bearing note (sounded sort of like seller financing "collateralized note"). They also made it sound like KPMG had approved of this by saying that KPMG had approved that the loan (from the former director to Zagg I guess?) was properly collateralized and was interest bearing. It was a pretty ridiculous statement - "KPMG has approved that this loan is interest bearing, therefor it fits the definition of a loan" = STAMP OF APPROVAL! BAM!
Otherwise their inventories soared again to be only ~3 turns/year on high growth and they had negative cash flow and got a $20M credit line against their receivables. So will they get a clean 10K?? It seems unlikely and seems certain there will be a NT 10K filed tomorrow since they, despite what they said on the CC, are an accelerated filer...
|Subject||RE: Covered 1/3 of the position here|
|Entry||03/25/2011 11:11 AM|
thoughts on the 10-K announcement?
|Entry||05/11/2011 11:49 AM|
"Not only will Sprint not comment in this press release, if we mention them by name they will sue us. GO ZAGG!"
|Entry||06/21/2011 07:12 PM|
I don't know anything more about iFrogs than what they said in the call, but I wonder if anyone knows what this is about? My first thought, since they're both Utah companies, is that maybe there's a family connection or something like that, but management said they first met at a trade show. If they're really cleaning up an accounting mess, why would they want to do a deal like this now?
|Entry||06/22/2011 02:39 PM|
I'd love to hear your current thoughts here. have you reshorted what you previously covered much lower? Do you still think it's as good a short as you initially did?
|Entry||11/11/2011 03:42 PM|
I think ZAGG could top conensus revenue for 2H11 by a substantial amount. See the pro forma disclosures. There are some 2011 EBITDA disclosures in the term loan agreement that make me not want to short this thing before the call either.
This is an obvious long term short, but it seems like we'll get a better entry point after the call on Monday.
|Subject||RE: RE: update|
|Entry||11/15/2011 09:58 AM|
So much for the better entry point. It seems like growth is kind of stalling out- I estimate that outside of iFrogz ZAGG was down Q on Q, which was not the case last year. In non-Best Buy channels outside of iFrogz revenue was down quite a bit. Combined iPhone and iPad units were down slightly sequentially in September, but organically ZAGG seemed to be down a lot more.
On the plus side they seemed to generate a little cash which somewhat undercuts the argument it is an accounting fraud. Gross margin looked good if you believe their adjustments. But that doesn't matter too much if people are wising up to the fact that the InvisibleShield is a worse-than-useless waste of money.
Any other thoughts?
|Subject||RE: RE: RE: update|
|Entry||11/15/2011 11:01 AM|
Zagg had upside in revenue and EBITDA for 3Q and 4Q guidance was higher. However, I would have expected a stronger 3Q if the underlying business trends were strong. Indeed, pro forma revenue was down 15% q/q in 3Q (not discussed on the call that I heard). It is not usually down q/q in 3Q as you point out.
iPhone shipments were down about 15% q/q at Apple, about the same as Zagg's 14% q/q decline in legacy Zagg revenue. You point out that combined with the iPad, Apple units were down slightly. Do you know what proportion of Zagg's business is tied to the iPad? Maybe not much? I was wondering if iPhone shipments being down q/q in 3Q at Apple might have pressured Zagg's Q3? If so, will the big expected increase q/q in 4Q iPhone shipments (I saw one analyst had 17m in 3Q going to 30m in 4Q) mean a stronger 4Q than expected for ZAGG?
Here's another negative for you... Zagg's online business was down 30% q/q and was 13% of revenue. This is after they said this on the 2Q call: ZAGG.COM IS NOW ONE OF THE TOP 250 US RETAIL WEBSITES AND NOW BY CARRYING IFROGZ, WE CAN FURTHER CAPITALIZE ON OUR WEBSITE TRAFFIC. ZAGG.COM WILL CONTINUE TO GENERATE STRONG GROWTH FOR THE REMAINDER OF THIS YEAR. AND THE ADDITION OF IFROGZ WILL HELP US IN MEETING ONE IMPORTANT ELEMENT IN OUR GROWTH STRATEGY, MAINTAINING ONLINE SALES AT 15% OR MORE OF TOTAL REVENUE, EVEN AS OUR WHOLESALE REVENUE CONTINUES TO GROW.
Don't get me wrong, like I wrote, I think this is an obvious long term short. But usually it doesn't pay to be short a high beta, high short interest stock when the company is going to beat and guide up, which they did.
|Entry||12/02/2011 02:14 PM|
Does anyone know what % of Zagg's business is tied to the iPad? If it is small, wouldn't the iPhone 4s shipping in October and Apple's q/q decline in iPhone shipments in 3Q explain Zagg's non-iFrogz revenue being down q/q in 3Q? And if that's true, wouldn't expectations for iPhone shipments almost doubling q/q in 4Q mean that Zagg could easily beat its 4Q revenue guidance? I get all the long term arguments against this one and it is one of only 30 companies on my quant short screen, but I want to get the timing right with a borrow rate of 42%. Is there evidence of impending margin pressure (besides margins being impacted by iFrogz)? Thoughts?
|Subject||RE: specialk, anyone?|
|Entry||12/08/2011 11:52 AM|
roc, it is hard to say what is tied to the iPad. But you bring up an interesting point that I have been wrestling with myself: Is ZAGG a smartphone play or an iPhone play? If ZAGG is a broad smartphone play, then I think we saw the first big cracks in their growth story last quarter as their largest customer Best Buy grew only 12% Y on Y and I would further note that BBY accounts receivable appear to be a very hefty 122 DSOs. To me this implies that either they stuffed the BBY channel at the end of the quarter to make their number or Best Buy is not paying for a lot of the ZAGG producs that have been shipped and are on their shelves. I have visited a couple of Best Buys lately and while iPhone SKUs are undoubtedly the best selling products, BBY is carrying racks full of InvisibleShields for seemingly every smarthpone and tablet in the store. By my rough count iPhone and iPad SKUs are probably 15% or so of the actual units at stores (although they probably sell through and are restocked faster). To me if Q3 smartphone sales were strong overall (but weak for the iPhone) this says that the third quarter should have continued to show strong growth. I think there is a high risk of a bunch of obsolete inventory at BBY stores for Acer tablets, LG phones, Blackberries etc. My checks indicate relatively few InvisibleShields are stocked at a lot of the iPhone channels like AT&T, Sprint and Verizon stores. That said, the Best Buy salespeople have told me that the shields sell well for all their phones.
If the non-iPhone units are mainly for show and only a very small part of the BBY revenue, and the business is majority tied to the iPhone, then it should bounce back with iPhone sales this quarter. But it would seem to be at least somewhat offset by weaker sales of all their other SKUs (probably at least 20) at BBY.
Any other opinions?
|Subject||CEO steps down|
|Entry||08/18/2012 08:49 AM|
hxf82, still following this name? The CEO stepped down. Sign of things to come?