By Jim Roumell :
ZAGG Inc. ( ZAGG ) announced a much worse than expected 2 nd quarter, sending its shares down to the $6 level. The company reset 2019 expectations and explained the shortfall overwhelming on weak mobile device sales as the iPhone 11 offers an insufficient number of new features to get consumers to the stores. The shortfall was explained, and we believe, it is a cycle issue that will be corrected with the introduction of 5G phones in 2020 (Samsung ( SSNLF ) in the 1 st Q and Apple ( AAPL ) in the typical fall launch season). The company's newly acquired businesses (HALO, Gear4 and Braven) all came in ahead of the company's revenue expectations. Thus, the company indicated 2019 should be a trough as the mobile replacement cycle begins next year driving its core screen protector business.
The company's newly issued mid-point guidance indicates a very cheap stock and compelling investment opportunity, in our opinion.
Revenue $535 million
EBITDA $57 million
FCF $40 million
At $6/share, ZAGG trades at roughly $175 million market cap and a $260 million enterprise value based on about $80 million of net debt. This translates to 4.5x EV/EBITDA, 6.8x earnings and a 15% FCF yield. The company also announced the hiring of Bank of America ( BAC ) to look at strategic options, evidently in part due to unsolicited private-equity interest as well as the company's own belief that its shares are not being properly valued in the public marketplace.
ZAGG fits squarely within RAM's sweet spot. Based on our analysis, ZAGG's core legacy business - high-end glass mobile screen protectors - is not actually distressed; rather its dramatic growth over the past five years has simply flatlined. The company's screen protector business produces significant free cash flow that has enabled the company to diversify its revenue stream by acquiring several adjacent business lines that also serve the mobile accessory market.
Legacy Asset InvisibleShield
ZAGG's anchor legacy asset is its InvisibleShield mobile screen protector business. The company's screen protector revenue in 2013 was $92 million versus 2018's $306 million (a steady 27% five-year organic CAGR). ZAGG is the screen protector market leader with an estimated 50% U.S. market share. Segment sales have increased as a result of the growth in smartphone sales, expansion of its distribution network, and benefiting from the industry's overall rise in "attachment rates," i.e., a greater percentage of mobile phone buyers purchasing screen protectors.
Wireless carriers like Verizon ( VZ ), AT&T (T), T-Mobile (TMUS), Sprint (S), and Carphone Warehouse (U.K.) make up roughly 48% of ZAGG's sales. Major retailers like Amazon (AMZN), Best Buy (BBY), Walmart (WMT) and Apple account for roughly 37% of sales. The balance of sales is comprised of e-commerce or smaller strategic retail stores. While Apple does not disclose its sales channel breakdown, industry insiders estimate that only about 15% of iPhones are sold at Apple stores. ZAGG built its business largely by servicing Apple's retail partners. For instance, Verizon, one of ZAGG's major customers, was the largest channel for Apple in 4Q18. Samsung and other manufacturers like LG and Motorola rely completely on carriers and retailers as they do not have their own stores. While Apple sells a number of ZAGG products, the company sells competitor Belkin's screen protectors, not InvisibleShield.
After years of steady growth, ZAGG's screen protector business has fallen, given anemic device sales. In our view, investors are overly obsessed with the company's stalled screen protector business (a cyclical issue), while ignoring ZAGG's emerging and quite promising, additional mobile accessory products. To wit, in 2015, screen protectors represented 67% of the company's revenues, in 2018 that percentage was down to 57% and in 2019 screen protector revenue is expected to be about 40% of total revenue.
ZAGG's vision is to be the leading mobile accessory product company (in power, protection and productivity), with a goal of reaching "$1 billion in sales and higher profitability." Logitech ( LOGI ), the industry leader in providing accessories to the desktop industry, has nearly $3 billion in sales, a $6 billion market cap and trades at 15x EV/EBITDA.
As the famous SNL character Chico Escuela (played by Garrett Morris) might say, "Screen protectors have been berry, berry good to ZAGG." The company's flat glass protectors sold to protect iPhones carry a gross margin of roughly 50% by our estimates (the company does not break out category margins, but carries a mid-30% overall gross margin). ZAGG gained its 50% U.S. market share position from its ability to quickly take a planogram (mobile phone design), manufacture the screen protector in large quantities and get it on retail shelves within two weeks. ZAGG's supply chain capabilities, dedicated customer service culture (providing a partial lifetime warranty valued by customers), and strong retail sell-through are at the center of its market-leading position.
The company is quite proud to note that three years ago, Car Warehouse, the U.K.'s "Best Buy" with 2,400 store locations, decided to go "in-house" in an attempt to capture the full margin on screen protectors. Car Warehouse came back to ZAGG within six months and re-established its relationship. This story was confirmed to us by a former high-level company executive.
The InvisibleShield product itself has long been recognized as setting a quality standard based as it is on using a clear thin film originally designed to protect the blades of military helicopters in harsh desert conditions. Nevertheless, there can be little doubt that competitive, and cheaper, products have emerged in the space. ZAGG must continue to innovate and emphasize strong customer service to retain its leadership position. One way that ZAGG differentiates itself is with its InvisibleShield On-Demand ((ISOD)) offering, where 550 U.S. locations, and 2,500 global ones, are able to provide same-day specialty-cut screen protectors for over 12,500 devices. Recently, the company introduced its InvisibleShield with VisionGuard to protect against harmful blue light, which received the endorsement of the Vision Health Advisory Board. The company is now also selling smartwatch screen protectors. On August 9 th , mophie (ZAGG's power products division) announced its new 3-in-1 charging pad that is designed to charge an iPhone, AirPods and an Apple Watch from one central location. The 3-in-1 pad will be carried on apple.com and select Apple stores. mophie is ZAGG's power products division and has the #1 US market share in battery cases at 67%, according to NPD/Retail Tracking Group's data as of December 31, 2018.
Notwithstanding its market leadership position, there are a variety of headwinds facing the company's InvisibleShield franchise. First, fewer mobile devices are being sold as the market matures and the replacement cycle is extended. In 2011, roughly 30% of U.S. adults owned a smartphone; today it's about 75%. Manufacturers are finding it more difficult to add features that encourage replacement and consequently device sales are down. This impacts ZAGG since an exceptionally high percentage of ZAGG's protectors are sold as a result of a new mobile device launch. Despite these recent trends, ultimately, we believe the company's screen protector business is likely to grow as a result of rising attachment rates. Attachment rates are still low overall in the mid-20 percent range, while up from mid-teens several years ago, according to NPD Group/Retail Tracking Service data.
Second, there is the perennial bear thesis that mobile device manufacturers will come out with a screen that does not need additional screen protection. For instance, Gorilla Glass is a brand of chemically strengthened glass developed and manufactured by Corning (GLW). It is used by the major smartphone manufacturers and is now on its 6 th iteration. While this risk cannot be ignored, RAM got comfort with this issue by noting the industry's rising attachment rate despite the steady rise in the strength of Gorilla Glass, which like all glass, still scratches. There appears to be a strong behavioral bias wherein people like buying the extra protection for their devices, which often cost as much as $1,000.
In fact, there does not appear to be a good reason why manufacturers would want to discourage the purchase of additional screen protectors as these products are highly profitable to the manufacturers' retail partners, who often make very little selling smartphones themselves. While device screens themselves have steadily gotten stronger, it has not been accompanied by any manufacturer encouraging its customers to forego additional screen protection. With the exception of Apple's modest iPhone store sales as compared to its overall sales, these partners are where the vast majority of device sales occur and undermining their profitability doesn't make economic sense.
Lastly, there are much cheaper, non-glass, screen protectors. While Amazon is sure to gain its share of business selling much cheaper screen protectors purchased by "do-it-yourselfers," point-of-sale buyer preferences, including having professional installation (avoiding the bubble issue), seem to limit the Amazon threat and provide ZAGG with a steady stream of customers going forward, albeit not nearly duplicating the growth rate the company enjoyed over the past five years. Moreover, carriers simply roll the screen protector price into the overall device cost, which is typically spread over 12 to 24 months, adding very little to the customer's monthly charge.
While we believe InvisibleShield's future is bright, it's difficult to know how the headwinds and tailwinds noted above will net out, over time. Fortunately, our ZAGG investment has real investment redundancy, dramatically increasing the probability of it being a successful investment.
In addition to InvisibleShield, the company's portfolio of accessories serving consumers' smartphone protection and power needs now includes the following brands: mophie (battery cases, external power packs and wireless charging pads), Gear4 (protective cases) and Halo (portable power). The company's current line-up offers a compelling portfolio of leading mobile lifestyle brands. The following market share information is provided by The NPD Group/Retail Tracking Service in the U.S. and by GfK for the U.K. for the three months ended December 31, 2018:
- #1 market share (51%) - U.S. Screen Protection
- #1 market share (23%) - U.K. Protective Cases
- #1 market share (35%) - U.S. External Power
- #1 market share (23%) - U.S. Wireless Charging Pads
- #1 market share (67%) - U.S. Battery Cases
Additionally, ZAGG has a small presence in the speaker and earbuds markets through its Braven and IFROGZ brands and also sells tablet keyboard products under the ZAGG brand itself.
ZAGG has made several acquisitions over the past few years. ZAGG purchased mophie in 2016 for $100 million, or effectively $85 million after a recent settlement with the seller over misrepresentation claims. The mophie acquisition immediately incurred problems as Apple did not provide the company with the necessary designs to enable it to market to Apple's newly issued phone models. Contemporaneously, Apple introduced its own battery case ($30 higher than ZAGG's). Apple no longer carries mophie's battery cases, but continues to sell its wireless charging pads and external backup batteries. In fact, on July 16 th , ZAGG announced that a select number of Apple stores will be expanding their mophie accessory offerings. In 2018, power cases and management accounted for $172 million in sales, or 32% of total revenue.
Today, mophie continues to be a premier brand widely recognized as the leading mobile external power company. The initial post-acquisition integration issues appear to be resolved. Chris Ahern, ZAGG's current CEO, moved his family from Scotland, where he was leading the company's European sales efforts, to California in order to steady mophie's sales and operations in 2017. After successfully completing that assignment, he was offered, and accepted, the company's CEO position and moved his family to ZAGG's headquarters in Salt Lake City, Utah, in March 2018.
In November 2018, ZAGG purchased protective case maker Gear4 for $40 million. Gear4's 21% U.K. market share results from its innovative specialty shock-absorbing material that lines its cases. The specialty material is licensed from U.K. company D30. It can be found in motorcycle and athletic helmet applications and has the unique characteristic of being a soft material that instantly hardens upon impact. Gear4 has a 4-year licensing agreement with D30 as its exclusive mobile accessory partner, with the option to extend at the end of four years. Gear4 received an excellent review in Forbes in March 2018 concluding, "The Gear4 Mayfair is available through the company's website for $59.99, which makes it $10 more than Apple's leather case option, but based on my experience with both, I would say the added protection and durability of Gear4's version makes the extra 10 bucks worth it." In May 2019, it was announced that Verizon will begin carrying a selection of Gear4 cases for Apple's iPhone.
Finally, in January 2019, ZAGG purchased power company HALO for $38.5 million. HALO is a leading direct-to-consumer accessories company with an extensive IP portfolio. According to the company, "HALO designs, develops and markets innovative technology products to make consumers' lives easier. This acquisition will enable us to enter new distribution channels, and to leverage new technology to enter into new consumer markets."
HALO's Bolt ACDC Wireless battery - "The Ultimate Power Source" - provides for multiple power back-up functionality. The Bolt, 7 inches by 4 inches by 2 inches, is a car jump starter, has an AC outlet (65 watts), LED Floodlight, 2 USB ports and wireless charging capability. It is a fabulous little box of power. HALO sells directly to consumers through QVC and HSN. In its HALO purchase, ZAGG not only acquired an IP-rich portable power company, but also opened up a new and exciting distribution channel at QVC/HSN where it expects to introduce other products. Historically, over 80% of Bolt sales occur in the 3 rd and 4 th quarters as QVC/HSN shoppers evidently find it to be a great gift idea. Check it out at www.halo2cloud.com . Bolt's Amazon reviews are excellent.
ZAGG has publicly said that InvisibleShield, Gear4 protective cases, and HALO power are above the corporate average of mid-30% gross margins, while mophie power, BRAVEN audio, iFrogz audio and ZAGG keyboards are at or below the corporate average. The company indicates it has a number of programs in place to drive costs out and believes it has a big opportunity to increase profitability on the mophie brand as it moves from an internally engineered product to a more factory-sourced model.
Valuation and Shareholder Return
We sat down with Taylor Smith, CFO, and were impressed with his capital allocation thought-process. After deep industry and product-specific due diligence, the company was particularly price-conscious, likely as a consequence of the problems encountered when it purchased mophie in 2016, in making the recent Gear4 and HALO acquisitions. Further, ZAGG is disciplined in its modest use of debt (the company has a low-cost variable rate credit line of $125 million that doesn't mature until 2023) and has stated its intention to limit debt to 1x EBITDA.
ZAGG consistently buys back stock and has repurchased roughly 8% of its shares, $50 million worth, over the past six years. In March of this year, the company announced a meaningful $20 million buyback (10% of ZAGG's market cap), signaling its confidence in the longer-term business outlook. The company has made clear that it is not considering any acquisitions for the remainder of 2019, and likely 1H of 2020, with its stated intention to pay down its credit line. Thus, in two years, $175-million market cap ZAGG could be near debt-free and generating over $40 million in free cash flow. We are not surprised that private equity financial buyers appear interested in ZAGG at current share price levels.
While consensus investors seem to be overly concerned about ZAGG's legacy screen protector business, and pricing the company as if it's an "ice-cube" given its 4.5x EV/EBITDA and 7x earnings multiples, we see a well-managed, conservatively financed company, leveraging its deep tracks into the wireless carrier and retail distribution markets in order to become a diversified mobile accessory market leader. In June 2019, ZAGG was named, "Accessory Manufacturer of the Year" at the 17 th annual U.K. Mobile Industry Awards. Further, given that 80% of the company's sales are in the United States, there are real opportunities to further grow its international presence.
ZAGG is not changing the world, it has no claim to cutting-edge cloud software technology and it isn't involved in A.I. ZAGG is, however, a trusted business partner intricately embedded into the ecosystem supplying protection, power and productive accessories to the new mobile-enhanced lifestyle. Properly understood, ZAGG is as much a B to B (business to business) company, as it is B to C (business to consumer); with #1 or #2 market share positions in its core product areas. While many investors chase popular, and often complicated 5G plays, we believe we found a simple one that should greatly benefit from the tailwinds of the game-changing functionality that the new network will provide to mobile users. In fact, there is increasing market confidence that Apple will introduce a broad range of 5G phones in 2020 after its settlement in April with Qualcomm (QCOM) and recently announced purchase of Intel's modem business. ZAGG's products may be commodities, but its business is a good one, in our opinion.
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