HEAR - Still Avoiding Turtle Beach

Summary

• The latest financial results are in, and in my view, they leave a lot to be desired. Although the company slashed costs dramatically, nothing can make up for revenue collapse.
• In spite of this, the shares are even more expensive now than they were when I recommended eschewing these shares earlier.
• Just because something rises in price in the short term does not mean it's a "good investment." If I were long here, I'd leave this party before it gets rowdy.

It's been almost four months since I recommended that investors continue to avoid Turtle Beach Corporation ( HEAR ). Since then, the shares have risen about 37.5% against a gain of about 15% for the S&P 500. The company posted financials since then, so I thought I'd review the name again to see if it makes sense to bite the bullet and buy back in, or continue to avoid the name. I'll make that determination by looking at the valuation also. I am in the mood to preserve capital, and I'm of the view that risk of a market drop is relatively high at the moment, so I'm predisposed to only buy into this business if the stock is trading for the proverbial "song" relative to the financial history.

We're all busy people. I'm assuming you've got exciting places to visit and interesting beautiful people to talk to, and I've got countless hours of "The Young and The Restless" to catch up on. Since you're busy, and because I'm absolutely obsessed with trying to make your reading experience as joyous as possible, I offer a "thesis statement" paragraph near the beginning of each of my articles. In this thesis statement, I provide you the gist of my thinking so you can learn quickly where I stand, and then get out before things get too tiresome. You're welcome. Although 2021 was a banner year for the firm, there's no getting around the fact that 2022 was much, much softer. Revenue collapsed, and, in spite of heroic efforts made by the company to control costs, net income dropped also. Long term debt is lower than it was in 2021, though it's still higher than it was in 2019. So in order to buy the stock, I'd need for it to be quite a bit cheaper than it was. It isn't. It's much more expensive than it was when I last looked at the name, so I recommend continuing to avoid the name. Of course, I may miss out on some future upside from the stock, but I am of the view that any gains made in stock price will be given back when this stock inevitably drops in price.

Financial Snapshot

When compared to the first nine months of 2021, the first nine months of 2022 were "troubled" in my view, driven mainly by a collapse in revenue. The top line was down fully 46% from the prior year in 2022, and all ills flowed from that. To express this in dollar terms, revenue was off by $117.7 million, and net income swung from $13.18 million in 2021 to a $36.3 million loss in 2022. That written, I will acknowledge that the rather heroic efforts the company has taken in reducing costs as revenues have collapsed. The cost of revenue, sales and marketing expenses, for instance, are down fully 33%, and 20.5% respectively from 2021. These reductions shaved about $62 million from costs. Given that, I think the $1.9 million uptick in R&D expenses is not too distressing. The problem here is the drop off in sales. In my view, it would have been impossible for the company to cut sufficient expenses to make up for the $117.7 million reduction in revenue from last year to this.

Also, we should remember that comparisons to 2021 are troublesome given that that year represented a multi year high point for the company. For instance, revenue in 2021 was about 56% greater than it was in 2019, so any comparisons to 2021 should be taken with a grain of salt.

Additionally, it's not all bad news at Turtle Beach. I like the fact that the capital structure has cleaned up dramatically from last year. Specifically, long term debt is about $11 million lower now than it was in 2021. If I were in an uncharitable mood, I'd point out that debt today is still about $18 million higher than it was during the pre-pandemic era, but the company is certainly moving in the right direction on this score in my view.

Given that the company looks bad relative to 2021, but that says more about 2021 than anything else, and given the fact that the capital structure is heading in the right direction, I'd be happy to buy back into the stock at the right price.

The Stock

If you subject yourself to my stuff on a regular basis, you know that I consider the stock and the business to be distinct from each other. The business manufactures and markets gaming headsets and sells them worldwide. The stock is a speculative instrument that gets buffeted by a host of factors, some of which have nothing to do with those activities. One of the things that affects the performance of a given stock, for example, is the crowd's ever-changing views about the desirability of "stocks" as an asset class. There's no way to prove this definitively, as it's an obvious counterfactual, but an interesting argument could be made to suggest that some portion of the 39% rise in Turtle Beach's stock since I last wrote about the name was in some ways a function of the 15% gain in the S&P 500. Additionally, people may decide to eschew the shares because Turtle Beach itself is following the pattern of shares that have been sold off by crowds in the past .

So, this is why I consider the stock as a thing distinct from the business. The former is often a poor proxy for what's going on at the company, and I think it's possible to profitably exploit this disconnect. In my view, the only way to successfully trade stocks is to spot the discrepancies between what the crowd is assuming about a given company and subsequent results. What I want to see in this regard is a stock that the crowd is somewhat pessimistic about that goes on to exceed expectations. When the crowd is pessimistic, the shares are cheap, which is why I try to buy only cheap stocks. So today the work involves deciding whether or not the shares are reasonably priced.

In case you don't have your copy of the "Almanac of Doyle's Trades" in front of you, I eschewed these shares earlier when the market was paying $0.44 for $1 of sales. Today, they're about 44% more expensive per the following:

Given that growth seems to be slowing, from an admittedly high peak, this higher valuation is a mystery to me, and suggests risk has expanded. My regulars also know that in addition to looking at ratios, I want to try to understand what the crowd is currently "assuming" about the future of a given company. If you read my articles regularly, you know that I rely on the work of Professor Stephen Penman and his book "Accounting for Value" for this. In this book, Penman walks investors through how they can apply the magic of high school algebra to a standard finance formula in order to work out what the market is "thinking" about a given company's future growth. This involves isolating the "g" (growth) variable in this formula. In case you find Penman's writing a bit too thick, you might want to crack the spine on "Expectations Investing" by Mauboussin and Rappaport. These two have also introduced the idea of using the stock price itself as a source of information, and then infer what the market is currently "expecting" about the future. Applying this approach to Turtle Beach at the moment suggests the market is assuming that this company will grow at a rate of about 15% in perpetuity from current levels, which I consider to be a very optimistic forecast, especially given what we've seen. Last time I reviewed Turtle Beach's stock, the market seemed to be assuming a growth rate of ~12%. Given the above, I think the shares are even more expensive today than they were when I last reviewed the name. Given that, I hope it doesn't come as a shock to you that I'm continuing to recommend avoiding the name.

For further details see: