E Turtle Beach With A Turnaround In 2020?

(Click on image to enlarge)

Source: created by the author

From the second half onwards the profitability is lower due to the acquisition of ROCCAT. But overall the diagram shows that approximately 40% of the yearly revenue is in Q4. I expect in particular the last quarter of 2020 to be exceptionally high.

Discounted Cashflow Analysis

While I start my stock analysis by looking at pricing strategies (multiples), I do a discounted cash flow analysis to look at the stock from a different perspective. If both methods indicate an undervaluation, I will add the stock to my portfolio. I chose a “high-growth” period of three years. Even though I disagree with a 5% revenue decrease, I used a growth-rate of -5% for 2020 and 3% for 2021 and 2022 to be reasonably conservative. 

(Click on image to enlarge)

Source: created by the author

I adjusted the cost of debt slowly to the industry average and the effective tax rate to the marginal tax rate. The reinvestment rate is relatively high in 2020, a result of the recent acquisition.

Because there are different methods to determine beta and the market premium, I will explain how I came up with a return on equity of 8.3% for Turtle Beach.

rf = 1.04%      10 year treasury bill rate

rm = 5.5%      implied market premium (I used Buyback + Dividends as Cashflow)

β = 1.61          transformed unlevered peer-group beta by using Turtle Beach's market value of equity and debt

(Click on image to enlarge)

Source: created by the author

Thereafter, I calculated the terminal value. I set the risk-free rate as growth rate. The debt to equity ratio is equal to the industry average. Over time Turtle Beach's ratios will approach the industry averages. Hence, I used the beta and cost of debt of the peer group.

(Click on image to enlarge)

Source: created by the author

Lastly, I discounted the terminal value and added it to the present value of the FCFF in the high growth phase. By subtracting the market value of outstanding debt, which are mostly operating leases, I get the fair market value of equity. Divided by outstanding shares the value of equity is $22.74/share. That implies the share is undervalued by 72%. Even if you consider a default probability of 40% and assume an equity value of $0 in the default case, you end up with a Value of $13.64.

Risks

In the following segment of this article, I will list risk factors for Turtle Beach, which could lead to a decline in revenues and profits.

China tariffs

At the moment (HEAR) isn’t paying tariffs on its products, in the event of continued trade negotiations, this might change. All of their products are produced in China.

(Click on image to enlarge)

Source: Turtle Beach 10Q 2019 Q3

Headphones are a product on list 4B:

(Click on image to enlarge)

Source: www.strtrade.com

For list 4B products, a 15% tariff was planned, but it was pushed back due to phase 1 of the trade deal with China.

View single page >> |

Disclosure: I am long HEAR.

How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.
Barry Glassman 4 months ago Member's comment

I think gaming companies are going to go way up as more and more cities are quarantined due to #covid19. What else will people do besides play video games all day! That's exactly what happened in China.

Robert Templin 4 months ago Author's comment

A good friend of mine had the same thought, although I think it might have an influence, I expect it to be a minor one and more of a short-term nature.

Barry Glassman 4 months ago Member's comment

Depends on how long this whole thing lasts or how far reaching the quarantines are. In China, where millions of people have been quarantined for months, from what I read, the impact has been significant.

Adam Reynolds 4 months ago Member's comment

Great read. I remember the Warcraft series fondly!

Robert Templin 4 months ago Author's comment

Thank you. I appreciate it a lot!