Skullcandy Remains a Head Case for Investors

Source: Skullcandy.

Here we are, seven months into the year, and Skullcandy (NASDAQ: SKUL  ) is back where it started at the beginning of the year. Having soared to over $11 a share in early March on better than expected fourth-quarter earnings, and getting a small bounce two months later when Apple said it was buying rival Beats for $3 billion, the headphones maker has squandered all of the gains, and investors seemingly have to start all over again.

Positioned somewhere between Beats and Bose, Skullcandy has found it difficult to establish itself as an iconic brand in part because it operates in what is viewed as largely a commoditized business, at least among the vast majority of users. It doesn't possess enough quality to be a premium accessory, despite its high retail price, and while it tries to enforce minimum pricing policies on retailers, at times cleaning out those who undercut it, consumers aren't always willing to pay those inflated values. 

Source: Skullcandy SEC filings.

It's had several well-received products like Crusher and Air Raid, but according to a survey released earlier this year by analysts at Piper Jaffray, Skullcandy products aren't commanding mindshare among consumers, receiving an ever-dwindling percentage of votes from those poised to buy headphones.

Whereas Beats controls nearly half the market, growing its brand-buying mindshare from 44.8% in the fall of 2012 to 46.1% this past spring, Skullcandy has shrunk from 14.1% to 9.8%, respectively. Apple, in spite of all the vaunted problems of having lost its "cool" factor, has grown from one-fifth of consumers planning to buy its brand to one quarter.

That sets up a challenge for Skullcandy to carry out its plan to build on its five pillars for the future, particularly growing its international business to half its total revenues, unless it includes the continued diminution of domestic sales. Although international sales were up 19% in the last quarter, U.S. sales barely budged higher to $29 million from the year-ago period.

Source: Skullcandy SEC filings.

Despite attempts at fusing music, fashion, and extreme action sports into a meaningful lifestyle brand, Skullcandy is subject to the fads inherent in each, which helps explain why it's had difficulty gaining traction. As the tumbling stock price shows, its footing with investors isn't so sure either, and though it routinely gets a bounce from persistent takeover rumors, that's proved an ephemeral route as well. It doesn't possess the cachet, talent, or product of a Beats to attract a buyer that would be willing to pay a premium for its business.

Worse, the retail landscape remains a wasteland. Many of the top outlets for its products are awash in a malaise that bodes poorly for the future. One of its premier partners, apparel retailer Tilly's, said it continues to experience weak consumer trends and guided second-quarter comparables to a decline in the high single digits, while Zumiez sees them decreasing in the low single digits.

It's also expanded its distribution to larger, mass-market partners, but their outlook isn't so hot either. Target is still reeling from its data breach scandal and dropped full-year guidance to $3.60-$3.90 per share from $3.85-$4.15 per share, RadioShack may be going out of business as it struggles to contain costs amid a dramatic falloff in business, and Dick's Sporting Goods sharply scaled back its comps guidance from a 3%-4% increase to just 1%-3% as gun buyers no longer feel the threat of further restrictions. In short, Skullcandy is going to face continuing difficulties making sales because its partners are suffering as well. 

The turnaround growth story is one that's trotted out by its ardent bulls, both product users and investors (many of whom are undoubtedly one and the same), and it's still in the very early innings of the makeover, but the company has yet to prove it's actually working. Skullcandy may be flat from the start of 2014, but if trends continue as they have been, this may end up looking like one of the high points of the year.

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