Turtle Beach Corporation: A small cap with potential.
Opdateret: 12. jul. 2022
According to Newzoo, the broader gaming market is the largest and most expansive industry in the world of entertainment. Hence, it is an interesting market to be in for most investors. Most investors know the large cap companies but there are also small cap companies with potential. One such company is Turtle Beach; the question is if now is the time to buy shares.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing this analysis, I do own shares in Turtle Beach. Turtle Beach is 2,34 % of my portfolio that you can choose to copy. If you want to copy my portfolio or just see which stocks that are in my portfolio, you can read how to do so here. I should also mention that I have reduced my position in Turtle Beach this year, as it previously was around 3,5 % of my portfolio. Despite me owning shares in Turtle Beach, I will keep this analysis unbiased.
Turtle Beach Corporation is a global gaming accessory manufacturer that is based in the United States. And while they are most known for their high-quality headsets, they also provide other accessories such as keyboards, mice, and microphones. They are mainly known for providing accessories to consoles, where they have a + 40 % market share in the United States, which is a market share they have had the last 12 years. Turtle Beach acquired ROCCAT in 2019, meaning they have stretched further into the PC market. Besides ROCCAT, they acquired Neat Microphones in 2021, which is yet another new market for Turtle Beach. The company has existed for more than 45 years, meaning that they have a vast experience in audio technology, and their products are sold in more than 40 countries. Turtle Beach is a well-known brand around the world, and as they have been able to get a + 40 % market share in the United States and keep it for 12 years, it is safe to say that they have a strong brand moat.
Their CEO is Juergen Stark. He has been the CEO since late 2012, and since 2020 the chairman of the board as well. Prior to arriving at Turtle Beach, he served as COO for Motorola Mobility Holdings, while he is also an entrepreneur, as he co-founded Centerpost Corporation before joining Motorola. He has a MBA with distinction from Harvard Business School, which means he certainly has the educational credentials in place. Unfortunately, I haven't been able to find much information about Juergen Stark but one thing I do enjoy is his frankness in the earnings conference calls. Personally, I think the earnings conference calls is a great way to judge management, and while I don't have much information about Juergen Stark, his frankness gives me confidence, and makes me willing to invest in the company.
I believe that Turtle Beach has a brand moat. While I don't have much information about the management, I know that the CEO has a vast experience in the industry and the educational credentials in place. I also feel very confident in the management when reading through the earnings conference call transcripts. Now let us investigate the numbers to see if Turtle Beach lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will look into is the return on investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all years. The ROIC of Turtle Beach is the tale of two halves. Up until 2017 the ROIC has been disastrous, and I wouldn't consider investing in a company that delivered that kind of ROIC. However, since 2018 the ROIC is well above the required 10 %, even though it does seem to go up and down. It is slightly concerning that the ROIC in 2021 is quite lower than the previous 3 years, and hopefully it isn't a trend. All in all, ROIC is acceptable because of the numbers of late but it will also be something that needs to be monitored.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. It is the same pattern that we saw when investigating ROIC, accepts for the outlier in 2014. There has been a change from 2018 and onwards, where Turtle Beach has increased their equity year over year. I find the equity growth acceptable despite the bad numbers until 2017, as we invest in the future and not the past.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Not surprisingly, we see the same patterns as when investigating the other numbers. Turtle Beach delivered bad numbers until 2017 and then we saw a change. However, the difference in free cash flow compared to the other numbers is that free cash flow is negative in 2021. It is not something you would like to see, and we will need an explanation. There are two main reasons, one is elevated freight prices in 2021, I will touch on that later in this analysis. The other is that Turtle Beach acquired Neat Microphones in 2021 in a $2,5 million deal. I would like to see a positive free cash flow and while there is an explanation for it in 2021, I would like to see positive free cash flow moving forward.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings. However, we were spared of doing the simple calculation, as Turtle Beach has no debt. I like to invest in companies with no or little debt. Hence, I really like this.
Based on the moat and the numbers, I believe that Turtle Beach is an interesting company but like with all other investments, there are some risks. Short-term there are two things that may end up impeding their revenue and that is freight prices and semiconductor shortages. In the latest conference call, the management specifically talked about how high freight prices affected their profits in 2021, and in the first quarter in 2022 as well. Gross profit margin has gone from 37,5 % in the first quarter in 2021 to 30,1 % in the first quarter in 2022. And while we might see lower freight prices moving forward, it will affect the bottom line of Turtle Beach, as long as they are elevated. Another risk is that they operate in a very competitive market. If competitors choose to reduce their prices, it could hurt Turtle Beach, either their profit if they lower prices themselves or the brand if they lower the prices, as it removes some of the exclusivity about the brand. Economic slowdown. An economic slowdown in the United States will hurt the gaming sector including Turtle Beach. In the first quarter earnings in 2022, management mentioned that U.S. video game accessory spending declined 16 %, headset market being down 35 % and PC accessories being down 25 %. It is due to factors such as the lack of stimulus check, more cautionary consumer discretionary spending caused by inflation and geopolitical concerns. It could get worse and affect Turtle Beach for some time to come. Finally, it is important to understand that a significant portion of their revenue is derived from a few large customers. Their three largest individual consumers accounted for 41 % of their sales. Turtle Beach does not have any long-term agreements with any of these customers or any agreements that they must purchase a specific number of products. Hence, if they lose any of these customers or they don't purchase as many products as expected, it will hurt Turtle Beach. However, their dependence on these customers is decreasing, as these three customers accounted for 47 % of sales in 2020.
Despite the risks, there are some good reasons why Turtle Beach could be an interesting investment. First, if you look at the last 5 years, Turtle Beach has grown at a CAGR of 17 %, while their long term-term growth goal is a CAGR of 10-20 %, which would be fantastic. Turtle Beach as many ways to reach that goal, the global software and accessories market is growing at a fast pace. Their investment in ROCCAT has also paid off, as two years after the acquisition it has already generated ten times the $11 million purchase price, and as the management says: "We are really just getting started". They launched four Neat microphones in 2022, which is just the start for Turtle Beach to dive into the $2,3 billion microphone market. In 2022 they also launched two new products in game controllers and fly simulation. Turtle Beach estimates that the third-party game pad controllers' market is a $600 million market, and their game controller has received great reviews, and Turtle Beach hopes to start winning market shares. The launch of their flight simulator was a success. The pre-orders sold out in less than an hour globally, and management expects the product to sell well in 2022 and onwards. Management believes that the addressable market for flight simulators is $400. One last thing that could cause the share price to spike is that Turtle Beach might be bought. Last year, Donerail offered to buy Turtle Beach for $36,50 per share, which is much higher than the current share price. The offer never came to fruition though, but rumors have it that Turtle Beach is actively looking for a buyer.
All right, we have gone through the numbers, potential and risks regarding Turtle Beach, and now it is time for us to calculate a price for Turtle Beach. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 0,91 (which is the numbers from 2021). I chose an Estimated future EPS growth rate of 15 (management expects to grow between 10-20 %), Estimated future PE 30 ((which the double of the growth rate, as the historically PE for Turtle Beach has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $27,30, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Turtle Beach at price of $13,65 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financials, keep in mind that all numbers are in millions. We cannot do that as Turtle Beach had higher capital expenditures than operating cash flow. I don't want to share the numbers from 2020, as 2020 was an exceptional year.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". The free cash flow per share last year was negative. Hence, it is not possible to make this calculation either.
I believe that Turtle Beach is an intriguing company with a solid brand moat. There are some risks both short-term and long-term. Especially short-term, Turtle Beach is affected by high freight prices and lower consumer discretionary spending. No one knows how long it will last and I'm not trying to guess. You must be aware of that as long as these things are happening, it will affect Turtle Beach. On the other hand, it probably won't last forever. More long-term it is a bit concerning that three customers' accounts for so much of their sales. However, it is nice to see that the percentage has gone down. I would like it to go down further by the end of 2022 and is something that needs to be monitored. Nevertheless, I find Turtle Beach intriguing. They are introducing new products that diversifies their portfolio, and if the gaming sector continues to grow, there should be room for Turtle Beach. Furthermore, we have these rumors about Turtle Beach being bought, which could give a spike to share price but that is pure speculative. If I didn't already have a small position in Turtle Beach, I would have opened a small position below the Margin of Safety price at $13,65.
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