Skullcandy Turns Takeover Target After 66% Drop: Real M&A

Skullcandy Inc., the headphone maker known for colorful designs, is turning into a takeover target after falling more than almost every other initial public offering during the past 18 months.

Down 66 percent since it began trading in July 2011, Skullcandy has performed worse than all but seven of the 185 U.S. IPOs completed since its debut, according to data compiled by Bloomberg. The stock sank to a record low of $6.70 last week after Jefferies Group Inc. recommended selling the shares. The company’s enterprise value of 3.9 times earnings before interest, taxes, depreciation and amortization is cheaper than 96 percent of stocks in the Russell 2000 Index, the data show.

While increasing competition for in-ear headphones and the company’s move into lower-margin designs prompted the Jefferies downgrade on Jan. 2, Skullcandy shareholder Royce & Associates LLC says its brand may appeal to buyers such as Bose Corp. or Sony Corp. Even though Skullcandy’s revenue growth has slowed, the shares have fallen more than is justified and that might prompt a takeover, Roth Capital Partners LLC said.

“I don’t get the sense that management is wanting or would look to sell at these levels, but you can’t ignore that as being a possible outcome when the stock’s trading where it is and the value being as cheap as it is,” David King, a Newport Beach, California-based analyst for Roth Capital, said in a telephone interview.

Alecia Pulman, a spokeswoman for Park City, Utah-based Skullcandy, didn’t respond to messages requesting comment. Joanne Berthiaume, a spokeswoman for Bose, said the company isn’t a potential buyer for Skullcandy. Sony’s Elizabeth Boukis didn’t answer an e-mail seeking comment.

Apple, Beats

Skullcandy shares fetched more than $16 as recently as August and peaked last year in April at $17.33. They plunged a record 16 percent on Sept. 13 after Apple Inc., the world’s largest company by market value, announced new earphones and Morgan Stanley cut its rating on Skullcandy’s stock. Jay Sole, an analyst at Morgan Stanley, wrote in a report that Beats Electronics LLC’s Beats by Dr. Dre brand was taking more market share than anticipated. He also cited the competitive threat from Apple, which bundles the devices with iPhones.

Losses accelerated for Skullcandy’s stock in November, when it slumped 29 percent to $8.62. The company cut its 2012 profit forecast on Nov. 1, citing a shift toward lower-margin products, “cautiousness” regarding European sales and U.S. promotions. Then, Skullcandy plunged 13 percent on Jan. 2 following the Jefferies downgrade, and closed at a record low the next day.

Earnings Multiple

The declines have left Skullcandy trading at one of the lowest valuations in the Russell 2000 Index, a gauge of smaller U.S. stocks. Its 3.9 multiple of enterprise value to Ebitda compares with the median of 9.3 among the 1,382 companies with a figure, according to data compiled by Bloomberg. More than $360 million has been wiped off the stock’s market value since a 2011 peak of $551 million.

Today, Skullcandy’s shares gained 3.9 percent to $7.14 for the biggest advance in six weeks.

Growth is slowing at the company. Annual revenue increases, which ranged from 36 percent to 47 percent in 2009 through 2011, are forecast to decelerate to 15 percent in 2013 and 3.5 percent in 2014, according to the average of analysts’ estimates compiled by Bloomberg.

Despite the pressure on Skullcandy’s business, the shares have fallen too far, and that could spur a deal, Roth Capital’s King said.

Other headphone makers may be interested in buying Skullcandy, said James Harvey, a New York-based money manager at Royce, which oversees about $36 billion including Skullcandy shares.

$350 Headphones

Bose, which produces audio equipment including $350 noise-canceling headphones, may be drawn to Skullcandy’s brand recognition and low valuation, Harvey said.

“The company generates cash flow and cash flow has been increasing,” he said in a phone interview. “That’s what we’ve been attracted to.”

Skullcandy produced $21.2 million of free cash flow in 2011, up from $12.1 million in 2009.

Larger electronic companies such as Sony could also see Skullcandy as a fit, Harvey said. Sony collaborated with TV personality Simon Cowell in September to release X Headphones in an effort to compete against Beats.

King, the Roth Capital analyst, agreed that an electronics manufacturer seeking to enter the headphones market, or bolster an existing business, might show interest in Skullcandy.

Skullcandy is popular among so-called action sports athletes, including skiers, King said. A traditional apparel company that already sells to that group may also be interested, he said.

The Center

“That customer is typically in that demographic that everyone is going after -- late teens, early 20s -- who spends more and more time on mobile devices and is consuming a lot of content on mobile devices,” King said. “Skullcandy is kind of at the center of that.”

Skullcandy may prefer to remain independent and expand with help from licensing agreements with other companies, said Sean Naughton, a Minneapolis-based analyst at Piper Jaffray Cos.

Still, Skullcandy’s low valuation may convince someone to acquire the company, Harvey said.

“The answer lies in how the potential acquirer views the Skullcandy brand,” he said.

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