Turtle Beach: Bears Are In For A Shock
https://seekingalpha.com/article/4247988-turtle-beach-bears-shock
Summary
Increased competition between Fortnite and Apex will increase the Battle Royale playerbase.
Speaking may not be necessary in Apex, but HEARing definitely is.
Apex Legends is available on both console and PS4, where Turtle Beach has significant market share.
Turtle Beach has an attractive valuation and multiple growth levers to pull.
After hitting a high above $30 in August 2018, Turtle Beach (HEAR) has declined by over 50% to around $15 as hype for the Battle Royale genre has died down. However, even as Apex Legends, created by Electronic Arts (EA), has continued gathering players, reaching 50 million players recently, Turtle Beach stock has moved nowhere. We believe this presents an opportunity for savvy investors to pick up stock for a low price before the next leg up.
Image result for turtle beach
(Source: Google Images)
Apex Legends - Why it matters
There is no question that Apex Legends is a groundbreaking addition to the Battle Royale genre. Despite our critique of its monetization scheme, we wholeheartedly agree that Apex Legend is an innovative new addition to the Battle Royale genre and a viable competitor to Fortnite. Despite large competitors like Activision (ATVI) failing to make successful Battle Royale games (Blackout, anyone?), EA's Respawn division managed to tick the right boxes and create the first Battle Royale game to hit 50 million players faster than Fortnite.
Apex Legends' success is extremely beneficial to Turtle Beach in a number of ways:
Apex Legends is available on PC, Xbox, and on PS4. This is perfect for Turtle Beach, which pretty much dominates the console headset market and has recently launched a new line of PC headsets.
Turtle Beach doesn't just depend on Fortnite, it benefits from any successful BR game. Since Turtle Beach sells headphones, any game that requires hearing basically helps increase Turtle Beach's customers.
Apex is helping to make the Battle Royale space more attractive to gamers by competing with Fortnite and forcing Fortnite up their game, which in turn would lead overall to more players for the Battle Royale genre.
Apex Legends opens up many sponsorship opportunities for Turtle Beach, considering many new streamers are now streaming the game.
Apex Legends - Requires HEARing
Interestingly, Apex Legends has a communication system that does not require speaking. Players can just point to an something to communicate to their teammates. This pretty much renders the use of a microphone obsolete. However, it still requires a good headset, as enemy footsteps, gunshots, etc. all need to be heard for the player to have a good chance of doing well. As Turtle Beach puts it:
If you’re playing an online multiplayer game that is even remotely competitive, you’re going to need to listen to your surroundings. You want to watch out for footsteps, and your fellow teammates spotting enemies. Even in a firefight audio reigns supreme. It can be incredibly easy to lose track of a player (especially if they’re using Wraith), so being able to Turtle Beach their movements is critical to winning. Keep those senses sharp and listen out for players using ziplines or running around in a nearby building.
- Source: Blog Post
Turtle Beach, having dominant share in the console market and having launched several new headsets in the PC market, is in prime position to ride the Apex Legends wave and prolong the success it has seen from Fortnite.
(Source: Investor Presentation)
A quick search for "Best headsets for Apex Legends" shows two results from Turtle Beach.
Newcomers to the Battle Royale genre who search for a good pair of headphones would most likely pick the Turtle Beach headsets, considering Turtle Beach is an extremely well-known brand and has some of the cheapest headsets on the market, which still provide great value for their users.
Apex Legends crushes the bear thesis
The main bear thesis on Turtle Beach mainly revolves around revenues and earnings declining significantly as Fortnite's player count declines. This bear narrative had already been crushed by the launch of Battle Royale modes in other games like Red Dead Redemption 2, but the final nail in the coffin is the launch of Apex Legends. The game's success practically guarantees that Turtle Beach will do well, regardless of what happens to Fortnite.
Firstly, Apex Legends will lead to an expansion of the overall Battle Royale space. No one is going to leave Battle Royale because Apex Legends launched. Instead, people who got tired of Fortnite will just switch to Apex Legends. Different people have different tastes - kids tend to prefer Fortnite, while older people tend to prefer Apex Legends. Apex Legends gives consumers more choice and will eventually lead to more consumers joining the genre.
Secondly, competition by Apex Legends forces Fortnite to improve its game, therefore in the end Fortnite itself would be a much better product, leading to more consumers sticking to it due to their higher engagement with the game. Fortnite has already copied Apex Legends' communication system, and will probably copy other good features from the game in the future.
In the end, a higher player count for both games will benefit Turtle Beach, helping to attract new customers and improve its upgrade cycle. Turtle Beach's supernormal earnings will only be prolonged with the addition of Apex Legends to the Battle Royale market.
Most importantly, Apex Legends proves that Battle Royale games aren't a fad, but rather a secular growth story. The fact that Apex Legends managed to grow faster than Fortnite despite coming out over a year later says something about how much people like Battle Royale.
Future growth drivers (Besides Apex Legends)
Other than Apex Legends, we believe there are many more revenue growth drivers.
Firstly, there is China. Turtle Beach is planning to heavily ramp up investments in China in 2019, as described in the company's earnings call:
This would include new geographies like China. China is the biggest gaming market in the world and virtually untapped by us. We’re making some modest investments this year that will further ramp in 2019 in this category.
- Source: Turtle Beach Q3 call
This gets us excited, as Chinese gamers will no doubt want cheap headsets, considering China's low GDP per capita, and who better to provide cheap headsets than Turtle Beach? China also opens up a host of esports opportunities, considering esports is growing many times faster in China than in the US. Another esport company we follow, HUYA Inc. (HUYA), is growing 100% YOY. China is a logical move for Turtle Beach, which already has a large share of the US and EU headset market.
Secondly, Turtle Beach plans to expand into other categories of gaming equipment, including mice and keyboards:
we expect to add roughly another $1 billion to our addressable market via non-headset gaming products, things like keyboards, mice and other gaming accessories and/or even expand into other gaming hardware categories.
- Source: Turtle Beach Q3 call
Although we don't have high hopes for this endeavor considering that this market is already highly saturated with well-known brands, this will doubtless help to increase revenues significantly.
The best thing is, Turtle Beach is now a lot more flexible than in Q4 last year.
(Source: Turtle Beach 10-Q filing)
As you can see, many of the long-term liabilities have been paid down and the previous shareholders' deficit of 22 million has increased to shareholders' equity of 23.4 million. Turtle Beach now has more breathing room to conduct experiments and invest in growth.
Turtle Beach still has an extremely low valuation
The company is expected to generate $3 in EPS this year, or 1/5th of its market cap currently, according to preliminary Q4 results. With Battle Royale doing better than ever due to Apex Legends' launch, and the fact that Turtle Beach had beaten its own preliminary results significantly in Q3, we believe FY EPS is in a strong position to beat analyst estimates.
(Source: WY Capital, SEC filings)
Our model projects a significant amount of operating expenses, as management has stated that they plan to invest in growth opportunities. We believe our model is ultimately conservative, as management did not forecast the launch of Apex Legends, and they are already known for their conservatism, having at one point forecasted Q4 2018 EPS to be below Q4 2017's EPS.
Either way, Turtle Beach is not richly valued, and future growth opportunities are discounted by the market. The market is pricing in a significant earnings decline, yet that looks more unlikely day by day.
Risks
The main risk we have discovered is that management is selling stock heavily and a major holder, VTB Holdings, is also selling. It's hard to tell why these parties are selling so heavily, but they may be looking to take advantage of the high price the stock is trading at.
Although some bears say competition is a risk, we partially disagree, as despite the fact some competitors are beating Turtle Beach in areas like high-end PC, no competitor dominates the low-end console market like Turtle Beach. We do concede, though, that it is possible that one day a competitor may launch a much better headset and steal market share from the company.
Overall, these risks are more than offset by the low valuation Turtle Beach trades at, so we continue to find the stock to be an attractive buy.
Takeaway
In the end, Turtle Beach is a company trading at a bargain valuation that may have been deserved in the past. However, with Apex Legends entering the Battle Royale market, this valuation now seems unwarranted and conservative. The stock hasn't budged despite the fact that millions of new customers are joining the game.
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