ArtistGNDphotography/E+ via Getty Images
When Turtle Beach Corporation (NASDAQ:HEAR) announced the acquisition of Performance Designed Products in mid-March, I believed it was game on. Shares had risen some 25% on the back of this announcement, on the back of a tender offer announced, as well as the release of quarterly results.
Believing that the deal for PDP would bring real benefits, I was a bit cautious at the same time, as the company had seen multiple boom-bust cycles in the past (and after a huge initial reaction of course), deciding to keep a close eye on the development going forwards.
A Gaming Play
Turtle Beach was founded in the 1970s, and over time has manufactured a wide range of gaming accessories, which moved along with the gaming and console cycles. The company develops and produces sound cards, headsets, music, and over time has focused more and more on gaming equipment. This includes specific game equipment, hardware accessories, controllers, headsets under its namesake as well as ROCCAT brand.
Amidst these cycles, the company has seen multiple boom-bust cycles with the last one taking the stock into its thirties in the post-pandemic era, after they fell back to the $10 mark earlier this year. These wild swings in the share price were correlated to the business performance, as a $150 million business a decade ago saw revenues peak around $350 million post-pandemic, but amidst a reversal of demand, Turtle saw sales fall to a quarter of a billion in 2022.
After a very tough year 2022, during which revenues plunged by 35%, and the company incurred a $51 million operating loss, a modest recovery was seen in 2023. Revenues eventually rose by 7% to $258 million, yet operating losses were still reported, although narrowing to $16 million. Fortunately, the company operated with a net cash position of $18 million, as expectations were very modest. A $10 stock earlier this year revealed that operating assets were valued at just around $150 million, based on a share tally of 17 million shares.
The reason for a non-demanding multiple and valuation was simple, as the company was not profitable, but that is all about to change as the company announced a $118 million deal to acquire PDP, one of its major competitors (notably in game controllers).
A Big Deal
With Turtle posting sales just exceeding a quarter of a billion, while posting single digit EBITDA performance, the purchase of PDP was set to be huge. The $118 million deal tag was not that much lower than the own enterprise valuation, but the (anticipated) implications are enormous.
Pro forma sales are seen at $400 million of which PDP is only expected to contribute some $120 million in sales, suggesting that the 1 times sales multiple feels rich (at the first glance) as the Turtle traded just over 0.5 times sales. That, however, is misleading as PDP posts better margins. Moreover, the combination expects to reap $11 million in costs synergies, as well as non-quantified revenue synergies, contributing more on top.
With an $80 million cash component, the pro forma implications can be modeled. With the shares issued to owners of PDP, I peg the share count around 22 million shares, with pro forma net debt seen at around $60 million. The net debt load will increase a bit, while the share count would come down, upon completion of an expected tender offering to the tune of $30 million.
Doing some modeling, I believed that pro forma operating profits might come in around $30 million, leaving potential for earnings of around $1.25 per share ahead of taxes and interest expenses. All this made me quite upbeat, but the big price action displayed by the shares, as well as multiple negative surprises in the past, made a wait-and-see-approach best advised.
Stagnant
After initial optimism in March, shares have largely traded in a $14-$17 range, now trading towards the higher end of the range as the market keeps digesting the deal.
In May, Turtle posted its first quarter results for the calendar year 2024. First quarter sales rose by 8% and change to $55.8 million, aided by the closing of the PDP deal late in the quarter (although its contribution has not been quantified).
The real gains were made on the bottom line. While operating losses improved modestly from $6.5 million this period last year to $5.7 million, it did come after a $5 million acquisition related charge, as otherwise break-even results might be in sight. These mark great operating achievements, driven by improved gross margins and operating expenses being reduced.
Adjusted EBITDA was posted around $1 million and change, as the company maintained the full-year outlook, calling for sales at a midpoint of $375 million and EBITDA at a midpoint of $52.5 million. Comforting was to see net debt at just $32 million as the company maintained cash holdings around $18 million and took out a $50 million loan for the PDP deal.
While all the numbers remain similar to the time of the deal announcement, net debt is lower, due to solid cash flow generation and the fact that the previously announced share tender has been replaced by a share buyback program.
With this deal, of course, closing already during the first quarter, frankly the only difference is that net debt which comes in lower than my pro forma numbers, always a comforting development of course amidst such a transformative deal.
Given this performance is largely in line with expectations, and while I have grown more appreciative of the business here following this transformative deal, the proof remains in the eating of the pudding as I am keen on learning more about the impact of the deal. For now, Turtle Beach Corporation is taking the conservative route regarding leverage, something which I can only applaud, as I am keen to learn more about the implications of the business here.
