Is Turtle Beach (HEAR) a Dank Gaming Stock?

By special request from a young man who hooked me up with a Starbucks (SBUX) gift card, I am performing an analysis of a fun company called Turtle Beach Corporation (HEAR). HEAR was founded in the 1970s to create sound cards, but switched jackets in 2005 to enter the more lucrative and exciting gaming industry. Over the last 15 years, it has carved out a solid following and is growing its business. The company has a lot to look forward to, but being a small company in a crowded space is a difficult prospect. Investors should look at HEAR as a growth opportunity, but do so cautiously. HEAR faces heavy competition.

tl;dr: HEAR's success will depend on its ability to develop strong products for the new console releases and maintain marketing partnerships with eSports teams and influencers. HEAR's stock is high compared to historical values, but its fundamentals justify this increase. Options are thinly traded so LEAPS are illiquid and spreads are inadvisable. Buy shares between $13-$20. Expect support at $18 (50 DMA), $15 (200 DMA), and $13 (50 WMA). Hold shares for speculation and a potential buyout.

HEAR: A Party Animal in a Crowded Room

The gaming industry is booming.

- eSports (or esports or Esports- no one really knows how to spell it) is expected to grow to almost 500 million participants in 2021.
- Microsoft and Sony have released their long-awaited Xbox Series X and Playstation 5 respectively, creating a whole new generation of games and gamers.
- The most popular games like Call of Duty reward players with deep immersion and competitive online play, inviting gamers to grab peripherals like headsets and speakers to get deeper into the game.
- The gaming industry features its own celebrities like Dr. Disrespect and StoneMountain64 to promote games and products, as well as entertain.

When it comes to the gaming industry, there is nothing to be bearish about. The hardware developers behind the boom come in various flavors. Turtle Beach (HEAR) competes primarily in the headset sector, creating arguably the most important periphery item. According to HEAR's November 2020 10-Q report, headsets make up 60% of periphery sales, making them a very attractive product line for manufacturers.

Companies large and small from every continent compete to create headsets. For HEAR, competition is fierce. SteelSeries, Logitech, Razer, HyperX, and countless others compete for gamer marketshare. Fortunately for HEAR, the gaming industry is large enough to accommodate more than one company, and HEAR is maintaining a strong presence. Their integration with new consoles, acquisition of Roccat to expand their products into mice and keyboards, and their marketing with influencers will help the company grow and carve out a reliable following. For a small company of about 350 employees (including Roccat), innovation will be important against much larger competitors like Logitech (LOGI).

Product Lines and Revenue-Producers

For what it's worth, there is a fashion element in headsets. Streamers want to look good on camera, and aside from a cool beard or zipper-busting cleavage, the hardware a streamer uses is the next most critical thing. HEAR produces good-looking headsets at a competitive price. Their product lines are compatible with the new console generation, and according to my work colleague Veals, HEAR "makes pretty good stuff." Overall, the company is in a good position to continue solidifying market share, which is already strong.

Bottom line up front: HEAR's ability to create high-end headsets to market to Series X and PS5 gamers are what will enable the company to grow. Its current trajectory indicates continued product development, but there are no indications of a "breakout" product to drive massive growth.

Above: Roccat items expand beyond headsets.

The Positives: 

- HEAR's PS4 and Xbox One headsets are compatible with the new generation. This will prevent immediate supply issues as gamers make the shift to the newest consoles.
- The company appears to have a strong refurbishing chain, allowing them to resell products alongside their new headsets. This creates opportunities to pull additional revenue with minimal overhead while maintaining marketshare.
- Influencers and Esports teams have a good relationship with HEAR, and their influence helps market the products at lower cost than traditional advertising.
- New headset models look good aesthetically, which is important when appealing to the burgeoning fashion industry behind streaming and allows the company to market well with teams and influencers.
- Acquiring Roccat, a German company primarily serving Europe, enables the company to go beyond headsets and into mice and keyboards. Having exposure to Europe diversifies the company's footprint, and comes as a package deal with Esports Team Roccat.

The Negatives:

- HEAR does not appear to have developed specific headsets geared toward the new console generation. They may not need to, but it would be helpful if the company creates something cutting-edge marketed toward new console gamers. (I was informed today that this is incorrect; Turtle Beach has Stealth 600/700 Series that are designed for the new consoles. This is no longer an area of weakness. I leave it here for reference)
- PC gaming is a less developed product line than consoles, and although PC gaming makes up a smaller proportion of periphery sales than console, it is almost certainly going to continue growing. HEAR's acquisition of Roccat will help, but Roccat is likewise a small company with heavy competition. Logitech (LOGI) appears much more competitive in PC gaming.
- Influencer and Esports teams are fickle, and any damaged relationship between them and HEAR will strain the company's ability to promote new products.

Financials and Fundamentals

HEAR is not a huge company, and there is nothing on the horizon that indicates they will grow massively anytime soon. A company with 245 employees (~350 with Roccat) and a market cap of $310 million, it pales in comparison to giants like Logitech ($15.5 billion). Still, that does not mean HEAR is not a worthwhile brand. Its shares have risen, and the fundamentals of the company support the rise. 

Bottom line up front: HEAR's growth will likely remain steady with no significant catalyst to change its trajectory. Its swing to profitability is notable, and tops-off its annual feast-and-famine cycle. It's low valuation makes it a buyout candidate.

The Positive:

- 45% of HEAR's revenue comes in the Sep-Dec quarter, likely because of Christmas.  This puts HEAR in an annual feast & famine cycle that makes it difficult to assess regular growth. However, it also creates a reliable sales quarter while other time is spend on research and development.
- The 10-Q from November indicates substantial financial improvement over the same period last year, including the important swing to profitability and ~200% increase in YoY revenue.
- Despite the Roccat acquisition, HEAR still has $27 million in cash, far more than the same period a year prior, indicating a strong balance sheet with reserves for a rainy day.
- The new console cycle will likely encourage gamers to purchase periphery products as well, including headsets.

The Negative:

- HEAR is dependent on in-demand games to drive interest in headsets. If 2021 does not have significant blockbuster games encouraging people to buy gear, then HEAR will suffer. This does not appear likely, but is possible.
- HEAR's liabilities and expenses incresed YoY, according to the November 10-Q, indicating increased costs of doing business.
- Mixed demand due to COVID-19 lockdowns may bring additional challenges to sales. Although lockdowns will drive people to game, the accompanying recession will dampen demand for luxury items like expensive headsets.
- Competitors like Logitech with much larger budgets likely have the capability to outspend HEAR in research and development, which could render HEAR's systems obsolete. On the other hand, competitors may be interested in buying out HEAR (and Roccat) due to its low valuation.

Stock and Technicals

HEAR's stock has bounced heavily from the March 2020 crash when it briefly became a penny stock. Its recovery to $20 after over a year of decline and recovery appears to be just as much fundamentally-driven as technically-driven, with its price increase justified by increasing revenue and optimism over new product launches alongside the new consoles. From a technical standpoint, the stock is in a consolidation pattern and needs a break above $22.50 to clearly demonstrate that higher prices are possible. The stock itself is relatively traded with an average volume of 515k shares traded each day. Options are not very liquid, with low volume (<30 on monthlies), no weekly options, and wide bid/ask spreads. 

Bottom line up front: Avoid HEAR options due to illiquidity and trade shares only. The stock is in a consolidation pattern and needs a break above $22.50 to continue its uptrend. 

The Positive:

- HEAR stock has been in an uptrend since March and has broken out of a long-term downtrend. This is a very positive sign and shows that investors are interested once again.
- Institutions own over 89% of outstanding shares, indicating high confidence that HEAR will continue to do well.
- 5/6 analysts rate HEAR a buy (1/6 rates hold), indicating smart money believes in the company.

The Negative:

- High institutional ownership may indicate that growth is already priced-in, meaning the lofty $20 share price may already reflect expected growth which may not translate into higher prices.
- Volume  on the stock is low, and options are not liquid at all. LEAPS have 0 volume and wide (20%+) bid/ask spreads. This makes trading spreads impossible and entering a LEAPS will force the buyer to overpay.
- No dividend and illiquid covered calls means HEAR is a growth play only with no prospect of making money off it without selling your holdings.

Above: options are not at all liquid, even the near-month expiration. Bid/ask spreads tighten near expiration, but are very wide on LEAPS.

Final Thoughts

Hear is a fun company. It makes good products in a competitive industry, and it is holding its own against much bigger competitors. Its acquisitions make it a viable candidate for expanding its footprint, but right now, it is still just a headset company with some mice and keyboards on the side. To really expand and make money for its shareholders, HEAR will need to expand its product line. Otherwise, it will be a great company with a below-average stock. More acquisitions can fuel this diversification. Moreover, HEAR's product line with an attractive valuation make it a potential buyout candidate, which would be a huge boon for shareholders.

Until HEAR decides to expand further or ends up with buyout offers, it is still best to hold a modest share position for speculation purposes. There are no viable options plays due to illiquidity.

I had to ask: 

1) Does Turtle Beach have any intention (or any need) to develop headsets specifically marketed for Xbox Series X or PS5 gamers? I notice that your featured headsets boast PS4/PS5 compatibility. Are there any features of the new generation that would necessitate or benefit from more precise engineering specifically for the new consoles?

2) While I am sure you cannot share specific information on potential acquisitions, can you share any information on Turtle Beach's strategic acquisitions plans? Does the company intend to continue pursuing acquisitions to expand your product line as was done with Roccat? What is the company's view on diversifying product lines beyond headsets and the much smaller mouse and keyboard products from Roccat?