CRSR - Event-Driven Radar: Turtle Beach Might Finally Get Sold

2023-06-14 09:41:43 ET

Summary

• Turtle Beach is an interesting activist pressure story that might finally be coming to an end.
• The company has recently announced several moves, including the resignation of its long-time CEO, the appointment of the activist Donerail’s founder to the board, and the launch of a strategic review.
• With the activist in full control of Turtle Beach, a company sale might be brewing.
• Public peer and comparable industry transaction multiples suggest the company might reasonably be worth $13.44/share in a potential sale, implying a 17% upside.

Event-Driven Radar is a series of articles dedicated to specific investment ideas where I expect short-/medium-term catalysts to help drive up the share price of the companies. The key aim of these articles is to succinctly highlight interesting investment situations, including their key aspects and risks. Some of these ideas will be readily actionable while others will have clear potential to turn into attractive setups.

Today's article covers the potential sale of Turtle Beach ( HEAR ).

What Happened?

Since 2021, Turtle Beach has been under heavy pressure from activist investor Donerail Group (currently owns 6% along with affiliated equity holders). The activist had pushed for a strategic review and made several offers to acquire the company. In May '22, Donerail came to terms with HEAR's management on an agreement whereby the company agreed to appoint three of the activist's nominees to its eight-member board, with two additional directors to be appointed if the company is not sold 4 months later. Eventually, the strategic review reached an unfortunate ending in Aug '22 as HEAR announced it had failed to come to terms with any potential acquirer amid a challenging financing environment and operational difficulties.

Several interesting developments have occurred since then:

• In Oct '22 and Dec '22, Donerail appointed two of its nominees to HEAR's board of directors, which expanded to nine members. The appointments, combined with the previously appointed 3 Donerail's nominees, gave the activist the majority control of the board.
• In Mar '23-Apr '23, activist investor Toro 18 Holdings acquired a 7% stake in the company and subsequently started pushing for the appointment of three of its nominees to the board as well as the launch of a strategic review. In early May '23, after raising its stake to 8.4%, the activist publicly criticized the botched sales process.
• Most interestingly, last month HEAR announced several governance/strategic changes, including the resignation of its long-time CEO, the appointment of Donerail's founder/CIO to the company's board as well as the launch of a strategic review.

Given that Donerail, which previously sought to put the company in play, now has full control of the board (6/9 directors) and the strategic review committee (2/3), the company sale might be among the likely outcomes here.

However, one strange aspect here is that shortly after the recent announcement of the strategic review, Toro 18 welcomed the move, withdrew its board nominees, and trimmed its ownership stake from 8.4% to 5% (selling shares at $12.11-$12.45).

What Does HEAR Do?

HEAR is a $196m market cap company that develops and markets gaming headsets, keyboards, mice, microphones, and other accessories. HEAR is one of the leading players in the US console gaming headset industry, with a 40% market share. The majority of the company's revenues coming from the headset segment. This implies cyclicality of sales as they typically follow releases of new gaming consoles or popular games. HEAR's products are primarily sold through major retailers, including Amazon, Walmart, and Target.

The company's profitability was boosted by Fortnite's popularity in 2018, with $58m in adjusted EBITDA. The profitability on adjusted EBITDA level declined to $23m in 2019 before picking up to $61m in 2020 on the back of the stay-at-home gaming boost as a result of COVID lockdowns. Last year, the business was significantly impacted due to deteriorating consumer demand, elevated freight costs, and excessive discounting by competitors. In 2022, HEAR printed an adjusted EBITDA loss of $19m vs +$37m in 2021.

Having said that, the management has noted that operational performance has already picked up driven by an increase in console sales (including the highest PS5 shipments in Q1 '23 in gaming console history), low HEAR's inventory levels (the lowest since the pandemic surge) as well as the launch of new products (such as Stealth Pro headset). The management has noted that the elevated freight costs and higher competitive discounting will continue to weigh on the operational performance during 2023, with an estimated adjusted EBITDA impact of $10m. HEAR expects $265m-$270m in 2023 revenues (~10% growth year-over-year) with $6m-$8m in adjusted EBITDA. With the expected dissipation of these negative impacts, the company might very well generate >$16m in normalized EBITDA. Note that this adjusted EBITDA figure would be in line with HEAR's estimated 2023 revenues multiplied by the low-end of the company's 2018-2021 adjusted EBITDA margin range of 7.5%.

How Much Could HEAR Be Worth In A Sale?

Peer and comparable acquisition multiples seem to suggest there is headroom for an acquisition bid above current share price levels. Assuming $16m in normalized adjusted EBITDA, HEAR is currently valued at a 10.9x multiple. The company's much larger competitors Logitech International ( LOGI , $10bn market cap), Corsair Gaming ( CRSR , $1.9bn), and GN Store Nord ( GGNDF , $3.3bn) currently trade at 15.2x, 19.6x and 13.4x 2023E adjusted EBITDA. Worth noting that, similarly to HEAR, the guided forward adjusted EBITDAs both of LOGI and CRSR have been significantly lower compared to CY2022 levels. Meanwhile, GGNDF, which has generally displayed more stable profitability in 2018-2022, is expected to reach and/or exceed its historical adjusted EBITDA high in 2023. Comparable industry transactions were likewise performed at higher TTM adjusted EBITDA multiples, including HP's acquisition of POLY (15.9x) and management's privatization of Razer (33.0x). I am unable to pinpoint what multiple HEAR might be worth in an acquisition, however, given these data points a 13x multiple on the company's normalized $16m in adjusted EBITDA seems to be reasonable. At this valuation, the company would be worth $13.44/share, implying a 17% upside from current levels.

Activists

Donerail Group is a value-oriented activist fund founded and led by former Starboard Value's partner Will Wyatt. HEAR is Donerail's only activist campaign. In Sep '22, Donerail Group reduced its ownership stake in HEAR from 8.7% to the current 6.3%. The stake reduction seems to have come primarily from the exercise of put options, which were acquired for hedging purposes. Donerail previously proposed to acquire HEAR several times at $34.50/share (Apr '21), $36.50/share (Jul '21), and $32.86/share (Dec '21).

Toro 18 Holdings is a part of Immersion Corp. Immersion is a $230m market cap company owning patents related to touch feedback technology (haptic technology). The company has been engaged in a number of patent infringement lawsuits against a number of large companies, including Apple and Microsoft .

Takeaway

HEAR is an interesting activist pressure situation with a potential near-term catalyst. Recent management changes and the launch of a strategic review suggest that the prolonged company sale might finally be coming to an end. A glance at HEAR's peers and comparable industry transactions suggests the company might be taken over at a quite sizable premium to current trading levels.

For further details see: