|Shares Out. (in M):||28||P/E||9.3||4.7|
|Market Cap (in $M):||215||P/FCF||5.5||4.0|
|Net Debt (in $M):||64||EBIT||34||60|
The March 2016 acquisition of Mophie, a manufacturer of back-up battery cases for smart phones, has a range of potential positive outcomes. Our base case is that Zagg will report $1.67 non GAAP EPS and $89 million EBITDA in 2017 as Mophie gross margins recover and the Mophie segment reports 12.7% operating margins. Even if our forecasts are too optimistic, we still expect Zagg’s stock price to out-perform given the overly conservative 2017 First Call estimates.
Zagg Report for-VIC September 23, 2016
There are four major product lines:
Invisible Shield (42% of rev) a transparent patent protected custom fit laminate that protects a smartphone glass screen from scratching and shattering. Zagg dominates this category with 53% dollar share.
Mophie (42% of rev) was acquired in March 2016. Ninety percent of sales are generated from the battery case product line such as the Juice Pack, which is a smartphone case with a second battery. Mophie dominates this category with 64% dollar market share.
Ten percent of sales are from various portable back-up battery formats.
Keyboards (10% of rev) For faster and more accurate typing a keyboard is a far better solution than using ones fingers to type lengthy documents on a tablet or smartphone screen.
Zagg is in the #1 position with 34% share of this category.
Audio (6% of rev) The iFrogz product line offers mostly headphones and earbuds for smartphones positioned as a value priced brand with Wal-Mart being the largest customer.
Geographis Sales Mix:
Zagg is a turnaround with a stock price that has lagged most indexes since 2011. Investor expectations are low as the sell-side has EBITDA estimates that are 6% below management’s guidance for 2016. Furthermore, valuation at 4.5x EV/EBITDA for 2016 is at a 27% - 67% discount to public peers and recent takeovers. The catalyst for improved stock performance will be driven by quarterly profits materially exceeding consensus. In a reasonable scenario Zagg’s stock price will double and reach $15 in 2017.
Mophie – The Largest Contributor To Higher Profits.
In March 2016 Zagg acquired Mophie. Current Sell-Side estimates for 2017 are below the 2017 estimates that existed before the Mophie acquisition in March 2016, so effectively analysts are assuming Mophie fails to make a profit in 2017. In fact the potential exists for Mophie to generate in 2017, $43 million of EBITDA. If you value this profit stream at 6x EBITDA, the $253 million in enterprise value is worth $9/share.
Mophie was acquired for $75 million which was a 0.41 price to sales multiple of 2015 sales of $185 million. Mophie had inventory of $42 million so Zagg paid under 2x times inventory for the company. Mophie was about to default on its bank credit line and this distressed situation allowed Zagg to acquire the company at a very favorable valuation. Mophie had losses of $32 million in 2015 which was mostly a result of a collapse in gross margins. In 2013 Mophie earned $27 million. So if Zagg can help Mophie recover to its profit levels of 2013, then Zagg will have acquired the company for 3x times EBITDA, and increased Zagg’s total corporate EBITDA by 40%.
The companies products remain very popular. In fact Mophie dominates the back-up battery case market with 65% dollar share. The #2 players are LifeProof with 15% share and Apple with 15% share.
In addition to having a brand name that defines the category, Mophie products are sold at retail at prices well below Apple and LifeProof.
The Mophie Financials table above shows that Mophie reported 33% gross margins in 2013.
Zagg believes that Mophie can generate 33% gross margins again. Gross margins have been depressed for the past two years because Mophie produced the wrong mix of battery cases for the iPhone 5 & 6. The company was forced to heavily discount its product to move the excess inventory. Zagg got lucky and has now been able to clean up its Mophie inventory. In July 2016 Pokeman Go for smartphones was released. This augmented reality game is a battery drainer. The average user was playing the game for 2 hours a day and draining their battery by 60% in those two hours. In July 25 million Americans were playing this game daily. Their smartphone batteries were running out of power in the middle of every day. This resulted in back-up battery case sales rising over 100% year over year in July. Mophie cases were sold out at Best Buy and back ordered on the internet. The good news is that Mophie was able to clean up its inventory which is the first step to having its gross margins return to normal levels.
Mophie’s losses were also a result of bloated operating expenses. Mophie is basically a one product company yet it had 315 employees compared to Zagg that has 215 employees and 65% higher sales. Even before centralizing IT, human resources, finance and manufacturing in the merger, Mophie should be able to reduce compensation expense by at least $10 million/year.
Mophie also wasted about $9 million per anum in advertising expense. The company tried to boost sales by doubling its spending on advertising . Unfortunately advertising costs rose, while sales failed to grow.
Five months after the acquisition closed Zagg management believes that it can operate Mophie even more profitably than it did as a stand-alone company. In addition to margin expansion, Zagg should be able to boost sales at Mophie as well. The back-up battery case category represents under 15% of all smarphone cases. Mophie was under-distributed before 2016 and only available for sale at 12 retail chains. In addition Mophie had no sales outside North America.
So we have three upside profit cases for Mophie.
Scenario #1 – Mophie profits recover to 2013 levels with 12.7% operating margins. This adds $0.60 EPS to the Zagg bottom-line.
Scenario #2 – Mophie operating margins reach 19% as additional synergies are achieved with Zagg. This adds $0.94 EPS to the Zagg bottom-line.
Scenario #3 – Pokeman Go is the first title in a new blockbuster category of augmented reality games that rapidly drain smartphone batteries. T
he number of augmented reality smartphone gamers will double as the variety of games expands. This leads to back-up battery cases doubling their
penetration rate to 25% of smartphone owners. Mophie is able to double its sales and EPS accretion is now $1.96/share.
The amazing part of the Mophie acquisition is that Wall Street analysts are assuming no profit contribution from Mophie in 2017. Investors are going to be delighted
even if only a fraction of the upside scenarios become a reality.
Other Sources of Upside:
My conservative forecasts assume that profits at the core Zagg business do not grow. In fact there are plenty of reasons to believe that profits will grow.
InvisibleShield (42% of rev) unit sales and average prices points should rise. The sharp reduction in subsidies offered by wireless carriers for new smartphones means that consumers are now paying $600 for a new iPhone versus $99 two years ago. This should result in consumers spending more money on products like InvisaShield to protect their smartphone screens from shattering or scratching. Thus the attach rate on new phones should rise. InvisaShield is also introducing premium versions of its products that sell at price points that are 35% - 200% higher. It is hard to accurately forecast , but positive trends for units and prices should lead to more dynamic sales growth for InvisaShield, the most profitable product line at Zagg.
Audio (6% of rev from IFrogz) The new iPhone 7 as of September 2016 has made wired ear phones obsolete. The new iPhone 7 is only compatible with wireless headphones. Normally, consumers do not purchase headphones for their new iPhone. They just continue to use their existing headphones. Thus Apple is forcing a massive upgrade cycle for the 60 million USA consumers that will purchase an iPhone 7 in the next year. Yes, Apple has provided a wireless earbud with the iPhone 7, but millions of consumers will be dissatisfied, and seek out a better product. Thus iFrogz which sells about 2 million headphone units per year could see their sales double in 2017. None of this upside is in my EPS estimates.
Zagg’s Valuation Could Rise Materially:
The closest public peer to Zagg is Skullcandy which has received a takeover offer.
If you apply the Skullcandy takeover valuations to Zagg based on equal weightings for 2016 EV/Sales, EV/EBITDA and P/E ratio, then Zagg is worth $13.93 or a 76% premium to its current stock price.
The next closest public peer is Logitech, which sells PC peripherals such as mice and keyboards.
Logitech is a mid cap stock which might explain why it has a much higher valuation, despite selling products into an even more mature and competitive marketplace than Zagg. If Zagg was valued on par with Logitech its stock price would be worth $23/share or a 196% premium to its current stock price.
Our Zagg stock price target for 2017 is $15/share based on the profit and valuation assumptions indicated in the table below.
1 - Zagg is in a fast paced smartphone industry where the vast majority of a products sales and profits are earned within 12 months of its introduction. If Zagg’s products are late to market, profits will suffer. Right now is a risky time for Zagg in the product cycle. The iPhone 7 (30% of estimates Zagg sales) was just shipped on September 16th, 2016. Zagg is in the process of designing and shipping the next generation of InvisaShield and Mophie products that will be compatible with the iPhone 7. Zagg has done this successfully many times before, but any unexpected delays in the shipment of the new products will hurt profits.
2 - Ninety percent of Zagg sales are linked to smartphones. Thus any decline in year over year unit volume of smartphone sales in North America will hurt Zagg. My profit forecasts for Zagg assume zero smartphone unit growth in 2016 & 2017.
3 - Zagg sells smartphone accessories such as InvisaShield, cases, headphones and keyboards, The OEM smartphone companies such as Apple and Samsung might decide to more forcefully enter this market.
This would harm Zagg as the OEMs have proprietary insight into the dimensions of their future products and can thus introduce smartphone accessories earlier than Zagg.
4 - A lack of product innovation by Zagg will result in gross margins declining over time and hurting profits.
5 – Over 10% of sales for Zagg are generated from Best Buy and Wal-Mart. Any deterioration in the relationship with these retailers will have a negative impact on profits.
6 - There smartphone peripheral categories are competitive. There is always a threat that new competitors will enter any of these categories with comparable products offered at lower prices.
1) Shipment of the new Mophie battery cases for the iPhone 7
2) Gross margins recovering at the Mophie segment.
3) Cost cuts being implemented at Mophie.
|Subject||questions re Mophie|
|Entry||09/26/2016 09:03 PM|
thanks for the idea. the success of this trade clearly hinges on how credible the Mophie turnaround plan is. with that in mind, what gives you so much confidence management can flip the switch and get margins back to 2013 levels so quickly if at all? You mention inventory mis-management re the Iphone 5/6 launches as causing the huge glut in inventory; are Zagg managers just that much better? It seems like a huge amount of margin accretion to have lost - over two full years - purely from inventory missteps.
It might be interesting to consider what mophie competitor ASPs have done in the last 2-3yrs. I imagine these things are pretty commoditized, and if mophie price points have been steadily discounted for years then perhaps looking at the comp to see what has happened in the space generally will be helpful. If, as I suspect, ASPs in general have eroded significantly (as battery pack cases have become more ubiquitous) then it seems unlikely 2-3yr ago levels of GMs are realistic. This would also make cutting advertising spend less feasible since presumably you need to advertise more in a commoditized space.
It is worth noting that in the first full Q from acquisition (Jun16), even adding back all the 'one-timers' and amortization of acquired intangibles, mophie was still a few pts negative operating margin. Is there any plausible explanation for this? I would have thought all the inventory issues were behind them by now (or is there a seasonal element here?)
Also you didn't mention if mophie has any IP/patent protection - do they? It seems Zagg does for their legacy products and have been able to defend margins somewhat in their screen cases, perhaps as a result.
On the other hand, I kind of agree mophie's costs are way too high - has the company quantified the SG&A savings they envisage and/or provided a timeline + cost to implement these savings?