Now that the post-IPO quiet period is over, a number of firms have initiated coverage on headphone maker Skullcandy (Nasdaq:SKUL). Does it really surprise anyone that the six banks initiating coverage on the stock were the six banks on the cover of the IPO? Likewise, does it surprise anybody that the coverage was universally positive? More and more, it seems like that "Chinese wall" between research and banking is creeping back to something more like the perforated Saran Wrap of the pre-tech bubble days.
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Whatever the conflicts of interest may, or may not, be, does Skullcandy deserve the love on its own merits? More to the point, can this company find a way to make a real business and real profits out of what has traditionally been a market bifurcated between throw-away, low-performance junk and super-high-end and very expensive gear for audio nerds?
The New Kid on the Block
Founded in 2003, Skullcandy hopes to bring something new and different to the headphone and earbud market - a market largely dominated by established names like Sony (NYSE:SNE), Philips (NYSE:PHG), Bose and Koss (Nasdaq:KOSS). What isn't clear yet is whether the company is bringing interesting new technology and features or simply new hype and marketing sensibility.
Thus far, reviews on the Skullcandy products have been mixed - some audio reviewers really seem to like them, others squabble and nitpick about the midrange sound quality and claim they're only suitable for rap or electronica (where strong bass works well). What is clear, though, is that the company is paying a great deal of attention to marketing and distribution. Skullcandy has made sure that its earbuds find their way into the hands of athletes, X-gamers, Djs and other so-called "image leaders." Consequently, brand recognition here is quite strong in the core youth market.
Just as wisely, management has made sure that people can actually buy these. Skullcandy seems to be doing an admirable job of creating the sense that their products are cool and exclusive, but they're actually widely available. These products are found in such everyday stores as Target (NYSE:TGT), and Best Buy (NYSE:BBY), warehouse stores like BJs, and sporting goods retailers like Dick's (NYSE:DKS).
Now the Tricky Bit
So far, Skullcandy is certainly doing well financially. Sales were up 46% in the last quarter and EBITDA was up a similar amount. In fact, Skullcandy has already grown to be the #1 player in earbuds and #3 overall in headphones (behind Sony and Monster).
The question is, though, can the company really make a go of this as a product category? Koss is a recognized brand with good low-end products and a relationship with Radio Shack (NYSE:RSH) but has seen revenue flag for five years. Bose has a network of stores around the country, but likewise found a ceiling to its market penetration (perhaps due in part to a very divided view on the quality of its products).
Plenty of hot products have jumped into the teen/young adult market, gotten a lot of publicity and initial sales growth, and then disappeared. Call it the Crox/Hot Topic effect. Then again, there have been hot products that have hit the market, garnered a lot of hype for the company, and then shown real staying power. Look at clothing companies like Under Armour (NYSE:UA) or lululemon (Nasdaq:LULU) or even Apple (Nasdaq:AAPL) as example of what can happen when powerful marketing is supported by legitimately good product.
The Bottom Line
It seems silly to spend real money on a music player and then lose out on the experience because of cheap headphones or earbuds. Maybe Skullcandy is simply testament to the idea that the right amount of marketing can turn practically anything into a prestige item. Or maybe this company really can develop solid products that deliver good sound quality and product life. If the company can back up the hype with quality, there's no reason the stock can't work and the company could well be a buyout target for a company like Nike (NYSE:NKE), Sony, or perhaps even Apple.
It's easy to be snotty about seeing a bunch of 'buy' recommendations coming from the same banks that just cashed fat checks for handling Skullcandy's IPO. The thing is, though, that the valuation here is not unreasonable if the company can continue to grow nicely. If Skullcandy can approach $500 million in sales by 2015 it will have not only accomplished something pretty remarkable in the audio industry, but should also be able to generate some real gains for shareholders. This isn't a stock for nervous hands, but investors who like to play growth and a little hype could find some winnings here. (For additional reading, take a look at How An IPO Is Valued.)
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