Apple Pure Play: ZAGG Poised For Another 400% Bull Run
7 comments | January 31, 2012 | about: ZAGG, includes: AAPL, ARMH, BBY, GLW, LOGI, S
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The recent price drop of ZAGG (ZAGG) due to iFrogz ownership lockup expiration, the 9 cent "one time" iFrogz inventory depreciation charge taken in the 3rd quarter, and end of year fund rotation, has made an extremely attractive entry point. Even the options activity in May is extremely heavily skewed toward out of the money calls. This is very telling as option players are usually considered to be more sophisticated investors. The options market is expecting a considerable move higher. With the recent pull back and options activity getting me interested again, I dug deep into ZAGG and did some considerable analysis. Additionally, I addressed many bear points. Bulls say that ZAGG is the major pure play on the success of Apple (AAPL). I now not only agree with this, but firmly believe that ZAGG is a pure play on the smartphone and tablet revolution the world is experiencing and will continue to experience for years to come. The following 11 reasons point to why ZAGG is set up for a 400% run in 2012.
1) ZAGG stands for "Zealous About Great Gadgets." ZAGG is a high growth company that is priced as if earnings is dropping. ZAGG continues to grow both the top line and bottom line every year. Since ZAGG started in 2006, it has almost doubled revenue every year and has already confirmed it has continued this trend in 2011. The growth trend is projected to continue in 2012. The following chart was taken from the ZAGG investor conference presentation last December.
ZAGG annual revenue growth
Since the presentation, ZAGG raised 2011 annual revenue guidance for the 4th time to above $175 million. This equates to 130% year over year growth. With the explosion of tablets and smartphones, growth is projected to continue for many years into the future. The original 2011 annual guidance was only $95 to $100M which ZAGG absolutely destroyed. EPS is estimated to be 48 cents in 2011 and 80 cents in 2012. Conservative analyst guidance has 2012 revenue estimated at $240M. Expect ZAGG to post 2012 revenue north of $300M and EPS to be over $1.
2) ZAGG is severely undervalued on a fundamental basis. ZAGG has a 2012 forward PE ratio of 12 much like Logitech (LOGI). The major difference is that Logitech is experiencing declining revenue and earnings and ZAGG is growing at a rapid clip. Considering the growth rate, ZAGG is extremely undervalued on a PE basis. Peter Lynch wrote in his famous book "One up on Wall Street" that a fair valued company has a PEG (price to earnings to growth) ratio of 1. ZAGG has a PEG of .73 for the trailing 12 months. Factoring in what is expected to be the largest revenue and earnings quarter in ZAGG history, the PEG will likely be as low as .50 when 4th quarter earnings get reported in March. Based on the fair value after 4th quarter earnings, ZAGG could be worth $17.12 per share on a PEG basis. Growth companies typically have much higher PEG when they are favored. Chipotle (CMG) has a PEG of 2.53, ARM Holdings (ARMH) has a PEG of 2.73, Amazon (AMZN) has a PEG of 6, Blue Nile (NILE) has a PEG of 2.42, Boston Beer Company (SAM) has a PEG of 2.99, and Corning (GLW) has a PEG of 2.14. If ZAGG gets valued by mutual funds as a growth company as history has shown it can consistently do, the PEG could double to over 2. This is equivalent to ZAGG over $34 per share.
3) Shorts and bears argue that ZAGG can't continue to grow its business. Bears have actually argued this the last 2 years as revenue and earnings have exploded higher. Bears point to the high margin Invisible Shield product that can be replicated cheaply by just about anyone. In December, Jim Cramer piled on to the short argument citing competition. This was only a couple months after Cramer said ZAGG was an Apple play and that hedge funds could take the stock up 20 points on momentum. The truth is that although there is competition, ZAGG is #1 in the fast growing smartphone and tablet accessory industry as reported during its latest investor conference. This is according to NPD research group, the source retailers rely on when ordering products. The truth is ZAGG continues to add SKUs to its retail channels and will successfully continue this trend the next few years. ZAGG has grown to over 20,000 SKUs with their high margin Invisible Shield. The model has been to get a foot in the door with a few SKUs in retailers, grow the relationship demonstrating superior products and filling orders timely, and then to expand SKU counts from there. ZAGG started with only a couple SKUs at Best Buy (BBY) and Target (TGT) a few years ago and have expanded significantly since. The same goes for expansion into Radioshack (RSH) and Staples (SPLS). If you go to any Best Buy, you'll see over 70 different ZAGG SKUs. In the last 15 months, ZAGG has entered all of the major carriers to include AT&T (T), Verizon (VZ), Sprint (S), Cricket, and T-Mobile.
ZAGG is replicating the Best Buy and Target strategy that has been a huge sucess. On top of the Invisible shield offerings, they are now selling new accessories such as the ZAGGsparq ($99 Power Charger), ZAGGwipes and ZAGGfoam ($5 to $10 cleaner), and the ZAGGmate ($99 iPad case/keyboard). ZAGG is cross selling iFrogz audio and cases with the Invisible Shield. Last December, ZAGG signed Microcel which is the largest accessories distributor in Canada. In 2011, ZAGG established ZAGG Europe, and are growing SKU counts oversees. The CEO has discussed setting up a distribution center in South America in a country like Brazil. As ZAGG continues to grow SKUs by taking up the shelves of all of the major retailers, it has been slowly overtaking the major point of sales in a highly fragmented market. Although bears and shorts contend there are no barriers to entry, it is much harder than it seems. Even if competitors manage to enter retailers, it is usually at one or two SKUs with little or no future expansion. Most in this space can't successfully compete with ZAGG. Difficulties include logistics, pricing, economy of scale, warranties, long payment times, and branding. Small difficulties often lead to small players getting dropped by major retailers.
ZAGG is the stalwart in this category that keeps expanding its footprint. Just this week, ZAGG demonstrated they are executing this strategy with AT&T stores. The last bastion for competitors has been the Amazon marketplace, where thousands of screen protectors are listed. Competition on Amazon is pretty difficult. ZAGG has a distributor on Amazon but does not focus its strategy there. Most people purchase screen protectors when they buy a smartphone or tablet. Shipping charges on Amazon make many competitors more expensive in many cases. Other lower priced competitors have such small margins that there is little ability to grow the business. Competitors have warranty issues as many of them are made in China or are made from non reputable companies. Trying to sell screen protectors on Amazon is not a very good strategy for growth. It is so difficult to compete on Amazon that no threat is likely to emerge online.
Taking over the major points of sale is the successful strategy. ZAGG is similar to many new businesses from technological revolutions such as the smartphone or tablet computer. It starts out as highly fragmented, but eventually a dominating leader wins and takes over a category. ZAGG is currently the growing leader that is rapidly dominating competitors and future competitors. The game is not if a company can make a screen protector, but can the company get the shelf space at the major points of sale (primarily where smartphones and tablets are sold), keep it, and then expand it. For as big of a threat bears say there is with no barrier to entry (as alleged with all ZAGG products), no major competitor has been able to emerge for the reasons stated above and below. ZAGG will likely double its SKU counts in 2012. Growth will continue through the smartphone and tablet revolution over the next few years. ZAGG is only scratching the surface in the number of SKUs it could eventually sell.
Just compare the growth in Apple in smartphones and tablets the last few years with ZAGG.
Now look at ZAGG the last couple years. Those that say ZAGG is not a pure play in the mobile revolution are blind to the facts. If you look at the huge jump in Apple iPhone and iPad sales in the 4th quarter, there will be an obvious correlation when ZAGG reports on March 12th.
4) Shorts and bears are becoming increasingly worried about recent analyst reports hinting that ZAGG is about to enter Walmart. Currently, ZAGG does not sell the Invisible Shield to Walmart (WMT) stores and has minimal presence on walmart.com. ZAGG does have a great relationship through iFrogz (a 100% owned subsidiary), which has grown from 1 product SKU in 2010 to over 45 active SKUs in Walmart. Because of the strong relationship with Best Buy, ZAGG has stayed away from Walmart in the past. With new product offerings to include the higher priced HD screen protection, ZAGG appears to have the green light to enter Walmart, according to analysts. Another big hint is cross selling which was a big reason why ZAGG bought iFrogz in the summer of 2011. ZAGG has slowly put ifrogz products in its existing channels. ZAGG has yet to be cross sold into the major iFrogz customer, Walmart. Expect this to happen in the near future, possibly in the 1st or 2nd quarter of 2012. Currently, iFrogz sells over a hundred thousand SKUs per week through Walmart. Once ZAGG enters Walmart, I would expect similar sales volume for the Invisible Shield which typically has a higher average selling price and gross margin than iFrogz products. Like with the third point above, a move by ZAGG into Walmart would devastate potential competitors. ZAGG would control most of the retail market.
As another testament to execution and strategy trumping "how easy it is to create a product," audio accessories and headphones are easy to make, yet iFrogz has succeeded in selling additional units each month, and not a Chinese copycat or some guy out of his garage. The fact is most US companies outsource manufacturing, including Apple as well as most successful product companies. Retailers and consumers go for US branded products for high quality, reliability, and warranties. On an annual basis to ZAGG, entering Walmart could add $60M a year in revenue in 2012 and over $120M a year in 2013. This is the worst case based on a slow roll out (100 thousand SKUs per month instead of a week like iFrogz in 2012, then 100 thousand SKUs biweekly instead of a week in 2013, and then up from there). Best case is that these numbers are extremely conservative.
5) The bears and shorts say that the invisible shield is a one hit wonder, yet ZAGG has continued to become a more diversified company. Product offerings continue to expand for both ZAGG and iFrogz and will continue to do so in 2012. At the end of 2011, the Invisible Shield made up 57% of total sales as other product sales grew. In 2011, ZAGG signed a deal with Logitech for the ZAGGmate (now Logitech keyboard by ZAGG) for the iPad and iPad 2. In late 2011, ZAGG launched additional tablet keyboards: ZAGGkeys flex, ZAGGkeys solo, and the ZAGGfolio. ZAGG now offers ZAGGskins and keyboard cases in the same colors Apple utilizes for the iPad magnet cover. At the end of 2011, iFrogz came out with 4 new headphones. In 2012, ZAGG announced the doubling of its keyboard production due to high demand. At CES 2012, ZAGG launched the Invisible Shield HD, a premium priced screen protector which could be an industry game changer. The Invisible Shield HD could become the "go to" screen protector for consumers during the smartphone and tablet revolution. ZAGG also demonstrated the ZAGGsparqcase.
Expect additional product offerings from ZAGG in 2012 as seen in the official 2012 CES video. In the video, the new ZAGGsparqcase is discussed as well as ZAGGdivide, ZAGG acoustics, and ZAGG aqua. The ZAGGdivide is a zippercase to compete with Targus and has recently started to sell on ZAGG.com. The video reiterates the goal of "quickly becoming a billion dollar company." This mirrors the 2009 company video when ZAGG was significantly smaller and the CEO stated the "billion dollar company" goal. The exponential growth performance of ZAGG since then gives huge credibility to the ZAGG executive team. Additionally, iFrogz is also launching new products in 2012. iFrogz is entering the gaming space with their "Caliber" headphones. iFrogz is launching "Boost" which is an iPhone speaker amplifier that uses near field technology. In 2012, iFrogz is also releasing new armbands, new types of cases, new "in ear" headphones, new power chargers, and new types of audio connectors. Expect all of these products to be in Walmart and other retailers in 2012 and to significantly boost ZAGG revenues.
6) Bears and shorts have ignored the patents that ZAGG holds and the huge positive implications for ZAGG. In June 2011, ZAGG announced that the US Patent Office issued the company a patent for wrapping electronic devices. This utility patent is not only for certain devices, but for all electronic devices until 2026. ZAGG has been in litigation with competitors for infringing on its patent. ZAGG, according to the last quarterly filing has already had numerous competitors settle out of court. ZAGG contends that it is remote that it will lose the remaining lawsuits for patent infringement, which would knock many other competitors out of the market in 2012. This is also keeping the potential of larger competitors away from this market. Reading the patent makes the ZAGG case look ironclad. In addition to the utility patent, ZAGG holds patent rights to the packaging and installation of screen protectors using sprays and squeegees from the Mason lawsuit settlement. The film manufacturer also holds patents on the nano memory making process in producing the material. The keyboards are patented as well as its audio "hanging tight" design. Currently, ZAGG has patent applications in for its ZAGGskins (printing designs/protection for the backs of electronic devices) as well as another patent application for wrapping electronic devices that piggybacks off its patent last summer. In a couple years, ZAGG could get the majority share of the entire US market due to its patents like 3M did with the post-it note from the 1970's to the 1990's. Wrapsol, a competitor, has been displeased with ZAGG having the patent. Wrapsol has stated that ZAGG has used its patents in pushing its products to retailers.
Just like with retailers not wanting to stock any iPod accessory without the official "made for iPod" logo because of patent infringement liability with Apple, retailers are progressively not wanting to stock competing screen protectors that infringe on the ZAGG patent. The same happens with Hasbro (HAS) and Mattel (MAT) in the toys industry. Chinese copycats can't get into US retailers, although many can certainly copy a certain doll or action figure. Copycats resort to online websites like Amazon, becoming a street vendor, or setting up in flea markets. Being the #1 selling and patented product continues to enable ZAGG to become the "go to" company in this space. Although, the success of ZAGG is largely attributed to the success of Apple, it is device agnostic, and will continue to experience huge success no matter what electronic devices are adopted.
Additionally, some bears point to gorilla glass being a threat. The gorilla glass in every iPhone and iPad still scratches. As a result, the bear's predictions the last couple years have been extremely wrong as the iPhone became the biggest Invisible Shield device in history. According to Corning, the new gorilla glass 2 is not scratch proof. Manufacturers want thinner and lighter glass that maintains strength. All current glass scratches. Future glass will most likely scratch. Owning this patent during the global trend of smartphone and tablet adoption positions ZAGG extremely well into the future.
7) ZAGG currently owns over 47% (37.5% when fully diluted) of HZO with ZAGG executives owning additional percentages. This gives ZAGG a controlling stake in promising company. The remaining owners are various venture capital firms. HZO owns the patent and additional US patent applications piggybacked on the patent for coating electronics in such a way the electronics work despite getting hit with water. Previous ZAGG bear and basher, Worthless Pennies, said the "Golden Shellback" technology (previous HZO name) was worthless as he bashed ZAGG. ZAGG has since received venture capital from 5 respected firms, most recently from one of Hong Kong's richest people. Search HZO online and there are many videos demonstrating the technology, most famously on Good Morning America at CES 2012. Here is another demonstration.
Numerous sites, including the New York Times, Consumer Reports, and PC World recently praised HZO at CES 2012. Many said it was the hit of CES and the thing to see. Additional info can be found on the HZO site. ZAGG and HZO had already said there was talks/negotiations with many different manufacturers in utilizing the technology via OEM deals. The manufacturers would license the HZO technology and build it into its process and then pay a royalty to HZO between $1 and $3. Since CES 2012, rumors spread through the web that none other than Apple and Samsung are now in talks with HZO for the next wave of phones this summer.
Apple is rumored to be looking at "waterblocking" the iPhone 5. The HZO technology has been developed over the last 5 years and has successfully demonstrated on numerous different devices such as headphones, smartphones, GPS devices, and tablets. There is no other technology like it (only water seal/coating companies who's products can't be submerged in water more than 10 seconds). There are different versions of "parylene coating," but none of them to the advanced degree HZO has developed it (otherwise, all electronics would be waterproof the last 40 years). HZO is able to waterblock the device in such a way that electrical currents can still pass by utilizing a new parylene compound in a $500 thousand dollar vacuum chamber. This is revolutionary, as other competitors can only seal electronics with watertight seals and apply basic "parylene coating." The result of competitor's process is that currents can't go through the coating. When water travels through the seal and outside coating, the electrical device dies. HZO representatives have been publicly stating the last couple weeks that HZO "waterblocked" devices will hit the market this summer. With production lead times being up to a few months, it is my hunch that some deals are already signed and that non disclosures are keeping it under wraps until the manufacturer announces. I even saw how HZO had a "OEM" page that listed all of the different manufacturer devices that have been fully tested but then took it down when the Apple rumors swirled (Samsung (SSNLF.PK) and Apple products were heavily displayed on the page).
What is also telling is that for the first time last quarter (as reported in the 10Q), ZAGG split out not only iFrogz revenue, but also split out HZO revenue going into the future. This can only mean the company expects significant HZO revenue in 2012 and wants to establish some year over year comparisons. "Waterblocking" has huge applications in smart phones, tablets, GPS devices, cameras, earpieces, solar panels, automotive circuitry, aerospace, medical equipment, marine equipment, and military equipment. Despite deals that might have already been signed, or will be signed in the near future not only with Apple and Samsung, but with many different manufacturers, HZO is currently not priced into ZAGG despite having over 47% equity. Even the value HZO received through the capital raises didn't raise the price of ZAGG stock. The market for waterblocking electronic devices is gigantic. Samsung is projected to sell over 150 million smartphones in 2012. Apple is projected to sell over 125 million iPhones in 2012. Millions more tablets are expected to be sold this year and many years into the future. Receiving a royalty of $2 from just these two companies would be hugely profitable for HZO to the tune of hundreds of millions. A couple hundred million in royalties each year could create a billion dollar valuation for HZO. Zagg gets a 5% fee from HZO sales as well gets the value of the growing equity stake. Like with EMC and VMW (VMW), this equity growth would be significant the valuation of ZAGG.
8) ZAGG is about to announce the biggest quarter in company history. In December 11, ZAGG raised annual guidance to above $175M. Through the 3rd quarter, Zagg had revenues of $111.5M. Doing simple math, this means at a minimum, ZAGG will have revenues of $63.5M. This equates to 38% quarter over quarter sequential growth and 117% year over year quarter growth. Not even some of the fatest growing publicly trading companies increase revenues this quickly on a consistent basis. Additionally, ZAGG usually has its big run ups with the big Apple iPhone launches. In the fall of 2010, ZAGG ran up from a couple bucks up to $8 as the iPhone 4 launched and adoption of the Invisible Shield was huge. With the iPhone 4S getting launched in October 2011 (with 37 million units sold) and the iPad 2 having a big Christmas (15M units sold), a record number of SKUs in retailers, combined with the 4th quarter always being their best quarter, ZAGG is poised to have a similar run up. The recent Apple and Samsung quarters show how fast the market is growing. This can only be good for ZAGG. ZAGG has already raised revenue guidance 4 times in 2011, but expect the company to beat it and post record EPS. Additionally, ZAGG is entering another big product year for Apple with the iPad 3 and iPhone 5 near release along with all competitor smartphones and tablets. The rumor is that the Apple TV will have a touchscreen remote. The market keeps growing.
9) Even Fibonacci ratios and Elliot Wave Theory support where ZAGG is projected to go. After testing the 9 month low, ZAGG reversed, setting up a double bottom reversal. This in itself is extremely bullish, setting up a potential run to $35. Some have pointed out that using the waves, the bull run from summer 2010 to summer 2011 was the "12345" movement and could only bring about a test of the low "[ABC]" to complete the first cycle. It now looks that December 29 is as a textbook low test as it gets. The wave is now expected to repeat a few times. According to the theory, markets move in wave cycles in the following sequence, and then repeat in multi-wave cycles.
Analyze Zagg the past 2 years. On December 29, Zagg retested the low "4" and is set up to repeat the 1 through 5 move again for the foreseeable future. This looks like a textbook pattern.
Since this is the first cycle, Zagg is expected to repeat the movements per the chart below. This takes the stock up toward $35 around December 2012, correcting again, before moving to a peak of $52. The peak is followed by a couple down cycles.
10) ZAGG could get bought out in a takeover bid. The most obvious candidate is Logitech International. On 4 Jan 12, Logitech submitted in a filing that it had taken out an additional $150 million on their credit facility for a total $400 million despite not having borrowed from the original facility yet. The reason why this is odd is that Logitech currently has $523 million in cash and has zero debt. The cash flow of Logitech is pretty impressive. The market is not currently favoring Logitech due to its declining revenues and earnings. It is not considered a growth company anymore. More importantly, Logitech is positioned for the PC business in a world that is moving toward smartphones and tablets. Logitech has been slow to adopt. A recent J.P. Morgan analyst report stated that Logitech was being left behind in lifestyle brands, specifically in audio and gaming. ZAGG is mentioned in the report as the iFrogz audio brand is a big seller in Walmart.
As noted above, iFrogz has entered the gaming space with new gaming headsets. Logitech has been slow to realize that style is big in the smartphone and tablet accessories market. I think they realize now that focusing on mice and keyboards is a big risk in the smartphone and tablet revolution. In the SEC filing for the $400 million credit facility, Logitech stated that the facility "may be used for working capital, general corporate purposes, and acquisitions." Logitech has enough working capital and cash for general corporate purposes. An acquisition is the only plausible explanation. The last major acquisition Logitech did was a couple years ago. Logitech bought a company for over $400 million which was over 4x the revenue of the company. A buy out of ZAGG would be at a minimum value of $700 million with current guidance. This is roughly $23 per share. ZAGG could have signficantly higher revenues in 2011. The acquisition makes sense because Logitech is currently a partner in ZAGG keyboards, are absent in lifestyle accessories, and do not sell screen protection. The ZAGG patents and the HZO stake adds considerable value.
11) A 41.64% short ratio (current as of 30 Dec 11) can cause a massive multi-day short squeeze when mutual funds start to buy ZAGG again. A rumor of going into Walmart caused a 13% bounce in ZAGG on Jan 13th. Actual news would cause the stock to shoot up, with short covering exacerbating the move higher and higher. The same would go for a HZO deal with Samsung and especially Apple. Record 4th quarter revenue and earnings along with optimistic 2012 guidance on March 12 could cause a large squeeze like in 2010. With many positive catalysts in the pipeline, the mother of all short squeezes could easily take this stock to north of $35 and into overbought territory short term. Shorts piled in on Sears (SHLD) at the end of 2011, but have been burned as Sears shot up 46% with shorting it becoming a popular trade. Like the famous 1929 story of Jesse Livermore knowing there was a top in the market when shoe shine boys would give him stock advice, and taxi drivers having hot stock tips in 1999, the same is true for shorts when a trade becomes extremely overcrowded. With amateurs like Jeff Reeves advising regular investors to short ZAGG on Fox News, Investorplace, Marketwatch, and Seeking Alpha with the same article as well as Motley Fool contributors piling in negatively and even Jim Cramer doing the same, you know the dumb money is in, and the bottom has been set.
The author as well as many readers of this article can easily refute what seems to be a poorly waged "short and distort" scheme by some hedge funds and all the classic signs of it. It has become comical the lengths individuals go to in order to manipulate a stock. They prey on fear causing a stronger reaction than greed. The internet seems to be the bucket shop of the 21st century. My following article will address the short and distort campaign on ZAGG and will address common rumors.
Disclosure: Author rode ZAGG up from $2.20 up to $8 in 2010. This next run looks even more obvious. Author is now long and will buy more as moves higher.
This article is tagged with: Long & Short Ideas, Long Ideas, Services, Specialty Retail, Other, United States
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