There was a time when ZAGG’s simple business of protective cases and skins for mobile devices seemed brilliant. ZAGG rode on the coattails of the success of Apple and Google Android devices, while peddling high-margin protective gear and accessories.
Although the South Salt Lake, Utah-based company started out creating thin protective coverings, branded as invisibleSHIELDs, it began offering headphones in 2008, followed by a hybrid case that includes a Bluetooth keyboard in 2011. That same year, ZAGG acquired its industry peer iFrogz, which also sell cases and headphones.
From its market debut in November 2009 to its all-time high of $16 in July 2011, it was smooth sailing for ZAGG.
But then the reality of rising competition and declining margins started to set in, and things fell apart quickly. Profit margin started to slide in the second half of 2010 into the holiday season, and operating margin began dropping at the start of 2011. This was a direct result of ZAGG lowering its prices to remain competitive in an increasingly crowded market.
For those investors who didn’t read the writing on the wall, revenue growth started outpacing earnings growth by the middle of the year. What happened next wasn’t pretty.
Although ZAGG’s revenue continues to rise, its margins are still plunging, to the point that profit margins are barely above the breakeven point. Over the past twelve months, revenue has risen 14.7% but diluted earnings per share have declined 37.8%. If this trend continues, the company will soon be unprofitable. Is there any hope left for this former darling of Wall Street?
We make SHIELDs, not barriers...
The simplicity of ZAGG’s business is also its greatest weakness. ZAGG has absolutely no competitive barriers to keep its competitors at bay. As long as Apple and Google mobile devices are popular, then nothing will deter other companies from producing similar protective products.
That weakness has allowed companies such as OtterBox, which produces cases for most iOS and Android smartphones and tablets, to easily steal market share from ZAGG. Research firm NPD Group ranks OtterBox as the number one smartphone case maker in America, based on February 2013 figures.
Another competitor, LifeProof, has gone one step further and manufactured waterproof, snow-proof and dirt-proof cases for mobile devices, making them an ideal choice for outdoor activities.
In the lower-end market, consumers can easily find cheaper alternative skins and cases online on Amazon and eBay, often imported from Asia. Meanwhile, higher-end consumers with more discerning tastes are buying more fashionable tablet and smartphone cases from affordable luxury brands Coach and Michael Kors.
Meanwhile, the headphone market is an extremely crowded one, where ZAGG runs into another cluster of competitors, such as Sony, Panasonic, Philips and Apple. Even Skullcandy, which creates large, fashionable headphones, has chomped into ZAGG’s share of the audio market.
Tougher phones and tablets
To top off all this misery in its two main markets, ZAGG faces technological advances from Corning that could render its invisibleSHIELD protective film completely obsolete.
Corning is the creator of Gorilla Glass, the tough scratch-proof glass that covers most modern smartphones and tablets. A second generation, Gorilla Glass 2, was released last year, and is now considered the industry standard. Last year, Corning reported that more than a billion mobile devices worldwide were protected by Gorilla Glass.
What’s more, Corning is creating a bendable glass called Willow Glass, which many analysts believe will be used in next-generation wearable technology products. Corning has already shipped samples of Willow Glass to smartphone, tablet and television manufacturers to see how the product can be implemented in new products.
In my opinion, the increasing toughness of Corning’s Gorilla Glass will cause consumers to completely ignore ZAGG’s products. However, they could still be interested in buying novelty cases as a fashion statement, and not for protective purposes.
I also believe that market aesthetics will change, especially considering the recent rumors of a transparent, scratch-resistant iPhone 6. Skins and cases might just end up looking tacky on these tough, futuristic devices.
Desperate times call for desperate measures
With its flagship products getting squeezed out of their primary market, and technological innovations threatening to break its core business model, what does ZAGG do? It gets very, very desperate.
As I noted earlier, ZAGG’s solution to keep up with its competitors is to lower prices. In other words, it hopes that a prolonged pricing war will halt the advance of its rivals, allowing it to grow revenue at the expense of declining margins and profits. That’s a very risky tactic, that runs the risk of bleeding its cash reserves and free cash flow dry.