Description

LOGI Short Thesis

In recent weeks, many “covid-winners” have sold off aggressively post earnings as growth expectations have been tempered with a more normalized operating environment and challenging comps. Examples of sharp pullbacks after earnings include: Fiverr down 24.1%, Etsy down 9.7% and Amazon down 7.6%.

We believe it is extremely timely to short Logitech (LOGI), a massive beneficiary of covid lockdowns and the resulting work from home trends. It fits everything we would look for in a “covid-winner” short:

1)      Massive beneficiary from covid in all measurable metrics: unit volumes, price, and margins

2)      Tremendous pull-forward in demand of mostly one-time purchases for products with very long replacement cycles

3)      Current stock price reflects a premium to its pre-covid valuation multiples and historical median valuation multiples on near-peak earnings

4)      Various data sources suggest the normalization of demand is starting to occur with price weakness already occurring in key products and slowing web traffic trends

5)      Many of Logitech’s products are commoditized with numerous competitors and limited brand loyalty

We believe the risk/reward is heavily tilted towards the downside over the next 12 months as investors will be forced to contemplate the normalized demand for various Logitech products, in particular webcams and video conferencing equipment, which we believe carry higher than average margins and have a ~7 year useful life. Applying more normalized margins and growth rates in a bear case scenario, we believe shares could trade at 14x 2022 EBITDA of $600 million, down 35% from current prices. Even if we are wrong and Logitech can maintain the current level of earnings, the stock appears fairly valued presenting very favorable risk/reward.

Massive beneficiary from COVID in all ways to measure it: unit volumes, price, and margins.

As the pandemic flipped the working world upside down with global lockdowns, sales of almost all of Logitech’s products exploded higher. Total revenue in FY2021 (12 months ended March 2021) was up a staggering 76%, driven by gains across nearly all of Logitech’s categories as many consumers rushed to buy the hardware needed to hunker down in a work from home environment. The unexpected spike in demand for webcams, keyboards, mice, and other computer accessories resulted in a very strong pricing environment leading to record margins. Logitech’s adjusted operating income margin nearly doubled from 13% in FY2020 to more than 24% in FY2021.

The table below shows the massive covid-driven revenue growth that started in Logitech’s fiscal 2021 first quarter. Logitech is about to start lapping extremely strong comps that will get progressively more challenging over the next few quarters. Recent trends suggest demand is beginning to normalize and expectations have not yet been reset.

The graph below shows the prior ten years of revenue and operating margin. As you can see, fiscal 2021 had tremendous outperformance relative to the prior trend.

Tremendous pull-forward in demand of mostly one-time purchases for products with very long replacement cycles

The frenzied buying as a result of the pandemic led to a tremendous pull-forward of future demand for Logitech’s products. At the end of calendar 2019, consensus estimates for Logitech’s FY2021 (12 months ended March 2021) revenue was $3.2 billion, which would have resulted in ~6% revenue growth. What actually happened, due to the pandemic, was Logitech’s FY21 revenue ended up being $5.2 billion, 76% growth versus the prior year. The revenue outperformance was a result of selling products that are typically one-time purchases, with useful lives greater than five years (when was the last time you replaced your mouse and keyboard?). At this point, we believe most consumers that need a mouse, keyboard, webcam, etc. for their home office now have the devices they need. In addition to computer peripherals such as keyboards and webcams, we have to wonder how much Logitech’s gaming segment, which nearly doubled to more than $1.2 billion of sales in FY2021, has benefited from stimulus spending. As a result of this pull forward and the one-time nature of purchases, we believe current revenue and earnings are unsustainably elevated. While we believe the post-covid level of normalized demand could be higher than pre-covid levels, comparables will be extremely challenging going forward.

Current stock price reflects a premium to its pre-covid valuation and historical median valuation on near-peak earnings

Logitech is currently trading 18x NTM consensus EBITDA, a more than four turn premium to its pre-covid five year median of 13.7x. Furthermore, this peak multiple is based on a near-peak level of consensus EBITDA of $951 million, which is more than 100% higher than pre-covid EBITDA of $430 million. We believe this combination of peak valuation multiple and unsustainably high earnings creates a dangerous combination with significant risk to the downside.

Various data sources suggest the normalization is starting to occur with price weakness already occurring in key products and slowing web traffic trends

We believe demand has already begun rolling over for Logitech’s products. Key products (as mentioned in the 10K) are already being discounted from pandemic-highs on Amazon:

The above graphs show that demand for Logitech’s key products is rolling over as current trends can no longer sustain the elevated level of product pricing. In addition to the softer pricing, attachment-driven Logitech volume could be pressured by chip shortage delays for computers. Even if post-covid normalized demand is higher than pre-covid demand, we believe pricing, and thus margins, are lower given increased supply.

While fiscal 2022 guidance assumes revenue for the remaining nine months of the year is down ~12% year over year, this is still nearly 70% higher revenue than the last nine months of fiscal 2020 (year ended March 2020). While we think highly of Logitech’s management team, we have low confidence in the guidance given their admitted lack of visibility into the business: “So our visibility Ananda as you know is not 9 to 12 months out. I mean, we have a pretty good visibility in the short term and some businesses like video collaboration we build pipelines and we see things further out, but we're staying with the same strategy. We're going to remain nimble, we're going to have inventory available to grow faster if the opportunity's there. And we're going to pull back hard if things slow down. And I think as Bracken mentioned in his prepared remarks, there's -- it's a little choppy, right? Europe look like it was on path to reopen strongly. And unfortunately, it's -- had to take a pause and I think, even in parts of the United States, we now see that as well. So it's hard to make long term prediction.” (CFO, 7/27 earnings call)

Furthermore, web traffic to the buy.logitech.com subdomain has returned to pre-pandemic levels:

Many of the products are commoditized, with numerous competitors and limited brand loyalty

Logitech’s products compete in fiercely competitive categories with limited perceived product differentiation among mass-market users and corporate buyers. When searching “webcam” and “keyboard” on Amazon, it is clear how intensely competitive these categories have become. Many products are sold under unknown brands at lower prices points, yet are highly rated with tens of thousands of 4+ star ratings.

Valuation

Logitech is currently trading 18x NTM consensus EBITDA of $951 million, which is ~120% higher than pre-covid EBITDA. If earnings normalize to $600 million of EBITDA (40% higher than pre-covid) and the stock trades at a historical multiple of 14x, there is more than 35% downside to current prices.

If consensus is right on FY2023 EBITDA of $915 million and the stock trades at 16.5x EBITDA (a premium to historical average but in-line with pre-covid valuation), Logitech is worth $104 per share or in-line with current prices. With multiple data points suggesting a normalization is already occurring, this strikes us as favorable risk/reward.

Conclusion

While we respect the Logitech management team and think highly of the business and products, we believe shorting Logitech presents an attractive risk/reward. Current earnings are elevated as a result of a pull-forward of demand for one-time purchases. Consensus estimates are too high and we believe earnings will “reset” lower once it is apparent that the covid tailwinds have subsided. If we are wrong on demand trends and earnings stay elevated, the stock appears fairly valued with minimal downside to the short. Additionally, we believe bearish options are attractive given low implied volatility and the challenging near-term comps.

Risks

Demand for Logitech’s products continues to remain at elevated levels.

Stock permanently re-rates to a higher valuation multiple.

Management uses the strong balance sheet to create value for shareholders.

Short interest remains elevated in Logitech stock.

Catalyst

-Miss vs consensus/Guidance Cut

-Normalization of demand trends

-Multiple compression