Turtle Beach (HEAR -2.12%) was one of the most volatile stocks of 2018. Surging sales of its gaming headsets, buoyed by the rise of “battle royale” games like PUBG and Fortnite, caused the stock to rally from about $2 in January to the low $30s in August.
However, concerns about its decelerating sales growth, its high valuation, competition from other headset makers, and its overwhelming dependence on a single gaming trend caused the stock to drop the low teens by the end of the year. The stock didn’t fare much better this year, and it recently plunged after its fourth quarter earnings report.
Image source: Turtle Beach.
What happened during the fourth quarter?
Turtle Beach’s revenue rose 40% annually to $111.3 million, beating estimates by $1 million but marking a major slowdown from its triple-digit growth in the previous three quarters. Its adjusted net income rose 51% to $21.5 million, or $1.33 per share, which also cleared expectations by two cents.
However, Turtle Beach’s guidance was bleak. It expects its revenue to rise just 5% annually in the first quarter and decline 14%-16% for the full year. On the bottom line, it expects its adjusted EPS to tumble 69% in the first quarter and 64%-70% in 2019. The full-year sales decline was in-line with expectations, but analysts had expected a milder 44% drop in its adjusted earnings.
Turtle Beach then made two unexpected announcements. First, it stated that it would acquire PC gaming accessory maker ROCCAT -- which makes gaming mice, keyboards, and headsets -- for $14.8 million in cash. It expects the acquisition, which should close in the second quarter, to contribute $20-$24 million to its revenues in 2019, $30 million to its revenues in 2020, and be accretive to its earnings the same year. Without that boost, Turtle Beach’s revenue forecast for 2019 would have broadly missed expectations.
Second, it stated that it will amend its second and third quarter filings due to the improper accounting of warrants issued in relation to a Series B share exchange last April. It expects to file the amendments by the end of March, and the changes will reduce its GAAP net income in the first three quarters of 2018 from $23 million to $14.6 million.
A double whammy of bad news
Turtle Beach’s downbeat guidance supports the bearish claim that it’s a one-trick pony which merely got lucky by launching the first wireless headset for Microsoft’s Xbox One as battle royale games gained steam in 2017.
Image source: Epic Games.
Moreover, Microsoft, Sony, Logitech (LOGI 0.84%), Razer, and other companies now sell similar headsets, and it’s doubtful that Turtle Beach can maintain its first mover’s advantage. Its unexpected acquisition of ROCCAT confirms that desperation, and CEO Juergen Stark’s claim that the purchase will help it build “a $100 million PC gaming accessories business in the coming years” indicates that it plans to become a more diversified player like Logitech -- which probably won’t ever replicate the massive growth of its core headset business last year.
On the bright side, Turtle Beach’s gross margin still expanded 90 basis points annually to 38.5% during the fourth quarter, so it hasn’t lost its pricing power yet. It also remains the leader in console gaming headsets with a 42% share of the market, according to GFK.
Unfortunately, Turtle Beach’s accounting issues raise serious questions about its management. Investors should recall that Turtle Beach isn’t a new company -- it was founded in 1975, changed its core businesses multiple times, and was passed between owners before finally being returning to the markets through a reverse merger five years ago. In other words, Turtle Beach shouldn’t be making major accounting mistakes which shave millions off its reported net income.
At $13, Turtle Beach’s stock trades at 13 times the midpoint of its 2019 earnings. That multiple might seem low relative to peers like Logitech, which trades at 20 times this year’s earnings. However, analysts expect Logitech’s revenue and earnings to rise 9% and 18%, respectively, this year -- while Turtle Beach faces steep double-digit declines.
Turtle Beach is an easy target for the bears
Therefore, Turtle Beach’s valuation now looks too high relative to its earnings growth. It faces incredibly difficult year-over-year comparisons in 2019, it faces tough competition, and the battle royale market could peak. Turtle Beach is trying to evolve into a mini-Logitech by buying ROCCAT, but that strategy could dilute its brand across too many PC accessories without significantly boosting its long-term growth.
Turtle Beach’s weaknesses have attracted plenty of bears, with 74% of its shares were being shorted as of Mar. 11. That high short interest might lead to a short squeeze, but those gains will be temporary unless Turtle Beach’s business stabilizes.
