Turtle Beach (HEAR -2.96%) 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, competition from other headset makers, and its overwhelming dependence on a single gaming trend caused the stock to drop to the low teens by the end of the year. The stock is trading around $13 per share as of this writing after it recently plummeted after its fourth-quarter earnings report.

A Turtle Beach gaming headset.

Image source: Turtle Beach.

What happened during the fourth quarter?

Turtle Beach's revenue rose 40% annually to $111.3 million during the quarter, 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 cleared expectations by two cents.

However, Turtle Beach's guidance was bleak, due to a projected decline in new battle royale gamers (although the new hit game Apex Legends might give the genre a shot in the arm), tough year-over-year comparisons, and higher promotional expenses. It expects its revenue to rise just 5% annually in the first quarter and fall between 14% and 16% for the full year. On the bottom line, it expects its adjusted EPS to tumble 69% in the first quarter and 64%-70% for the full year. The full-year revenue decline matches expectations, but analysts had projected a milder 44% drop in its adjusted earnings for the year.

Turtle Beach also 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 million to $24 million to its 2019 revenues and $30 million to its 2020 revenues, and be accretive to its 2020 earnings. Without that boost, Turtle Beach's revenue forecast for 2019 would have missed Wall Street's expectations.

Second, Turtle Beach stated that it will amend its second- and third-quarter filings due to the improper accounting last April of certain stock warrants, which are similar to options but directly issued by the company for new shares. It noticed that the warrants were incorrectly reported during a year-end audit.

The changes will reduce its GAAP net income in the first three quarters of 2018 from $23 million to $14.6 million. That $8.4 million reduction is significant for Turtle Beach, which generated just $39.2 million in GAAP net income last year (after the reduction). However, investors shouldn't fret too much about the change, since it looks like an isolated mistake and won't impact its previously reported revenue, gross profit, operating income, adjusted EBITDA, or cash flow.  

Check out the latest earnings call transcript for Turtle Beach.

Is Turtle Beach a one-trick pony?

Turtle Beach's downbeat guidance supports the bearish claim that it's a one-trick pony that merely got lucky by launching the first wireless headset for Microsoft's Xbox One as battle royale games gained steam in 2017.

A scene from Epic Games' Fortnite shows a woman with a rifle

Image source: Epic Games.

Moreover, Microsoft, Sony, Logitech, 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 it knows it needs to branch out, and CEO Juergen Stark's claim that the deal will help it build "a $100 million PC gaming accessories business in the coming years" indicates that it wants to become a more diversified player like Logitech. But it probably won't ever repeat the massive growth of its core headset business last year.

On the bright side, Turtle Beach's gross margin 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 in North America, with its regional market share rising from 42.4% to 46.1% between 2017 and 2018, according to NPD.

At $13, Turtle Beach's stock trades at 13 times the midpoint of its 2019 earnings estimate. 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

Turtle Beach's valuation looks too high relative to its expected earnings growth. In 2019, it faces tough year-over-year comparisons, rising competition, and a potential plateau in the battle royale market. It's trying to evolve into a "mini-Logitech" by buying ROCCAT, but that strategy could dilute its brand across too many accessories without significantly boosting its long-term growth.

Turtle Beach's weaknesses attracted plenty of bears, with 74% of its shares shorted as of March 11. The high short interest might lead to a short squeeze if any positive news prompts the bears to cover their positions, i.e., buy shares, but the gains should be temporary unless Turtle Beach's business stabilizes.