Turtle Beach: Recall, Seven Other Issues Pose Significant Downside Risk

by Sonya Colberg, Senior Editor - 10/26/2015 11:16:05 AM

After living on Easy Street for a month, even while feverishly discounting products, Turtle Beach Corporation (HEAR) is now quietly recalling $6 million in next-gen products.

The recall of almost 60,000 China-manufactured gaming headsets began last week, according to the US Consumer Product Safety Commission. The recall came after consumers reported mold on gaming headsets, posing a health risk.

The XO FOUR Stealth headsets were sold in stores and online this year from June to September.

Here’s a snapshot of the government notice:

(Source: US Consumer Product Safety Commission. Click for more details)

The recalled headsets, recently introduced for Xbox One console game systems, are core to Turtle Beach. Gaming headsets account for nearly every penny of sales.  

This recall represents just the very latest downside risk to Turtle Beach.

Investors may find other viewpoints here, but TheStreetSweeper presents other challenges poised to make turtle soup of this stock.

*Terrible Timing

Significantly, the recalled units are part of the next generation headsets that the CFO says were critical to the small sales hop to $22.6 million last quarter (though 6-months’ revenue fell 30 percent below last year).

“Strong consumer response to our expanded portfolio of next generation headsets” primarily drove that little quarterly improvement said CFO John Hanson.

The recall couldn’t come at a worse time.

Video gaming companies introduced the Xbox One and PlayStation 4 in 2013 to try to wake up gamers who’d fallen asleep at their old, no-longer-exciting consoles. Companies wanted to quickly offer headsets for these new consoles. But Turtle Beach fell a little behind the curve, for instance, because it couldn’t get its hands on a headset adapter for Xbox One until March 2014, four months after the system came out.

Meanwhile, gamers have been turning up their noses at old-gen game consoles and the headsets that go with them. Rapidly.

“…the transition from prior-gen to next-gen consoles will and has put pressure on our operating results and the decline in old-gen consoles and associated accessories continues to be faster than we or analysts expected,” said CEO Juergen Stark.

That means the company is forced to spend big bucks advertising old headsets and tossing them into the bin at huge discount.

*Discounting Pain

The company’s stuck with a growing truckload of inventory: $37 million worth.

Turtle Beach has been forced to hold a fire sale. An Amazon search reveals discounts as high as 70 percent:

(Source: Amazon.com)

Discounting can’t be casually swept aside. Well-heeled first-party companies like Microsoft can command greater market share by discounting and bundling.

But that blue-light special discount essentially steals from smaller, cash-poor companies. Look at how a couple of small Turtle Beach rivals have crumpled as they faced heavy discounting.

Here’s the LeapFrog (LF) stock chart, showing an 84 percent drop this year:

(Source: Yahoo Finance)

The discount bin is also eating into Skullcandy (SKUL), despite that company’s cushion of better margins of 42 percent versus Turtle Beach’s low 15 percent margin. Skullcandy stock has fallen 28 percent this year:

(Source: Yahoo Finance)

*Headset Status: Popularity Appears To Decline

Comparing Turtle Beach headsets with other companies’ headsets, a couple of troubling issues emerge.

First, the influential PCGamer.com recently ran an article comparing the best gaming headsets, here. Turtle Beach didn’t even get a mention.

And sales of $186 million fell significantly below the $205 million reported just three years ago.  The dollar share was 53 percent then. It’s 49.1 percent now.

Google search trends show gamers are vastly more interested in Microsoft’s own gaming headset than Turtle Beach. Even Skullcandy brand Astro attracts more interest. See below:

(Source: Google)

*Next Thing: Cash Drain, Late To Market

What about the prospects of Turtle Beach’s secondary product, HyperSound?

The company owes a lot – almost an 80 percent jump in stock price – to the CEO’s mention of an upcoming initial shipment of HyperSound Clear.

But TheStreetSweeper is concerned about the irrational exuberance surrounding this old, expensive technology whose chief accomplishment is draining Turtle Beach.

The company has already sunk about $10 million on HyperSound directional speakers, primarily on research and development, and appears on track to drain another $10 million this year.

When they do go to market, the units are expected to cost $1,500 and anticipated to be used by people positioning the units near their television sets.

But, as an author beautifully explains, high price is the largest barrier to entry for hard-of-hearing folks.

If people want to plunk down over $1,000, they may be more likely to go with hearing aids.

In fact, research shows subjects vastly preferred the sound of speech (shown in red below) heard through hearing aids over PSAPs.

(Source: audiologyonline.com)

If hard-of-hearing people prefer a PSAP (personal sound amplifier product), the market is already flooded with competitors’ cheaper products, suggests an audiologyonline.com interview.

Indeed, consumers can also buy a competitor’s more mobile sound amplification device for just about $70.

A fresh rival is also undercutting Turtle Beach prices with a couple of new audio transmitting devices for just $249 to $269.

*Lawsuits: Uncertain Costs, Potential Stock Dilution

HyperSound technology ended up under Turtle Beach through a reverse merger in 2013 that an ongoing shareholder lawsuit alleges resulted in breach of fiduciary duty. This litigation is costly, distracting and the ultimate decision stands as another question mark.

Another shareholder filed a lawsuit in February that could result in the redemption of his stock. An unfavorable judgment could unleash the plaintiff’s stock - worth around $15 million. So, the plaintiff’s potential sale of millions of shares poses a massive risk of dilution to stock held by other shareholders.

*Another Financial Backer Special

Money-losing Turtle Beach’s pathway circled around MDB Capital, a firm which underwrote Parametric Sound Corp. in 2012, just before it merged into Turtle Beach.

TheStreetSweeper has warned investors about a number of risky MDB-associated companies, including Resonant (RESN ~$14 StreetSweeper publication day, now   ~$3.90), Uni-Pixel (UNXL ~$7 publication day, now ~$1.20 per share) and Clearsign Combustion (CLIR ~$6.79 publication day, now ~$5.80 per share).

MDB Capital is known for taking on extremely risky companies. We’ve seen so many of these deals go south that we consider any MDB Capital association another great reason to dash the other way.

Indeed, Turtle Beach’s stock ranged from $1.75 - $6.08 over the past year and has fallen more than 38 percent since the 2012 MDB underwriting.

*Poor Financials

Quarterly net revenue remained flat compared with last year, yet salary expenses and losses rocketed.

(Source: Company SEC filing)

Six-month comparisons more fully indicate the seriousness of the matter:

(Source: Company SEC filing)

So, even before the recall, Turtle Beach reported increasingly negative earnings per share, rising losses and deteriorating sales.

*Who Loses; Who Wins?

While shareholders watch Turtle Beach’s losses exceed last year’s losses, executives are rolling in compensation totaling $6.6 million.

(Source: Company SEC filing)

What happened to the stock price during the time executives were pushing wheelbarrows in to carry off their compensation?

The stock fell 78 percent:

(Source: Yahoo Finance)

Golden parachutes will land CEO Juergen Stark and CFO John Hanson gently and prosperously upon their termination and resignation plans – handing them up to $1.2 million combined.

*Insiders Selling Company Stock

Meanwhile, it looks like a big insider is cashing out.

In the past year, even with the stock as low as $2.21 per share, beneficial owner Carmine Bonanno has stayed as busy dumping stock this year as last year. Earlier this month, Mr. Bonanno unloaded more than 96,000 shares.

It’s sure not the first time insiders have pulled out the stops. Cofounders Mr. Bonanno and Frederick Romano – who pulls down $1,635 per day working as the company’s operations and supply chain advisor – sold 371,500 shares to “a group of institutional investors” in August 2014 as shares traded close to a 52-week-low following an earnings miss.

(Source: Nasdaq)

*Earnings Misses Common

Looking at earnings misses, Turtle Beach has a bad habit of disappointing analysts. And even if earnings uptick in the last quarter, analysts predict a 2015 earnings loss to investors of $-0.29 per share. History suggests it won’t even make that, as shown below.

(Source: Yahoo Finance)

Just that much more silliness for this stock with a ridiculous forward price-to-earnings of 84.75, and a $143 million market valuation.

*Conclusion

Turtle Beach is wading into a big recall of next-generation headsets – presenting a giant question mark on the ultimate monetary and reputation costs. Meanwhile, the company deals with having to discount headsets more rapidly than expected while its market share declines to 46 percent from 49.1 percent in 2013. At the same time, Turtle Beach losses mount up by the multi-millions.

And TheStreetSweeper can’t imagine its secondary product HyperSound living up to the rushed, irrational exuberance that recently set the stock on fire.

Sure, Turtle Beach argues the $1,500 HyperSound price tag is cheaper than hearing aids.

But HyperSound is late to market, already roughed up by much cheaper, effective alternatives. Research shows people prefer the voice quality of hearing aids over all the PSAPs, anyway.  And let’s face it. People can pop hearing aids into the ear and go. But no one’s going to drag along a pair of these 7.4-pound speakers and amplifier boxes the next time they visit the theater or grocery store.

All considered, this Turtle Beach hot stock will get freeze-dried and we see over a 50 percent downside from here.

* Important Disclosure: The owners of TheStreetSweeper hold a short position in HEAR and stand to profit on any future declines in the stock price.

* Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to [email protected].

 

 

 

 

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