Zagg: Dog or Just an Underdog?

Short-sellers and hedge funds may be shadowy, but sometimes they are the smartest guys in the room. They've done their homework, and they're willing to bet their capital against the crowd -- an investing strategy that can be as lucrative as it is contrarian.

On Motley Fool CAPS, the 180,000-member-driven investor community where informed opinion is translated into stock ratings of one to five stars, we've also got investors who find the chinks in a company's armor and correctly call its fall. We call them "Underdogs" if they've earned 100 or more CAPS points by correctly predicting that one or more stocks would underperform the market.

Today I'm looking at smartphone accessories maker Zagg (ZAGG +0.00%), which lost nearly half of its value after it was revealed that its former CEO had margined more than half his company stock and abruptly resigned. With allegations charging the company had launched a secret campaign to replace him before the brouhaha became public, the stock has never really recovered and continues to trade lower today. Investors remain wary, so there's little wonder the accessories maker carries the lowest CAPS rating of one star.

Admittedly, it's been a long ride down, so if there are any CAPS players who've scored big by correctly predicting this stock will fail, it may be worth our while to check out those they think will ultimately succeed. And CAPS All-Star wolfersmith is one who's earned the underdog moniker and recently predicted Zagg would rout the shorts.

Zagg snapshot

Source: FinViz.com. TTM = trailing 12 months. N/A = not applicable; Zagg doesn't pay a dividend.

Of course, not every short-sale goes as planned, which makes shorting a risky proposition. Stock prices can be irrational longer than you have money to stay in the game. And you don't want to end up with fleas by lying down with dogs, so it's important to do your homework.

A scary opportunity
On one hand, Zagg has a lot going for it. Its core line of products is tied to Apple's many i-devices, which up until just recently, anyway, were a surefire sales machine. It bolstered its business by acquiring iFrogz, which expands the product category to higher-end headsets and earbuds, and it just announced a deal with Tech Data (TECD +0.00%) to provide the distributor of IT products and services with the full range of products for its 60,000 clients. With Wal-Mart added to the roster of retailers selling Zagg's invisibleSHIELD as well as a push into the gaming market, there's a lot of heady optimism for the future.

Unfortunately, that's about as far as it goes. Zagg's products are commodities facing a host of competitors from Best Buy's Rocketfish and Logitech to next-gen protective technology coming out of Corning and GT Advanced Technologies. My own iPhone is protected with an OtterBox case. The move into the earbud market is merely a sideways step, another commoditized niche where Skullcandy can't gain traction and has to resort to steep price discounting to move product. With Apple offering its own improved earbud, the hits keep coming.

Moreover, as its indirect channel sales program expands at retailers such as Best Buy, Staples, and Target, we're likely to see margins compress, particularly with Wal-Mart added to the mix. The indirect market now accounts for 83% of revenues, up from 79% in the previous quarter, and margins slipped 100 basis points to 45%.

A smaller piece of the pie
While management points out the mobile-computing accessories market this year will be a $20 billion business and growing to $60 billion by 2015, demand for the iPhone 5 is much weaker than anticipated. Now that Zagg is mired in lawsuits and investigations, the field is open for peers like OtterBox to make timely acquisitions. It recently wrapped up Wrapsol, which makes screen protectors for handsets, tablets, and laptops.

I continue to believe the accessories maker is a dog, but let me know in the comments section below why you don't think investors will gag on Zagg.