Description

Logitech is the only tech company I’ve owned during the last 4 years.  They’re a consumer electronics company that is frequently ignored by investors and analysts despite a remarkable record of success in the cutthroat world on CE.  All they’ve been able to accomplish in the last 10 years is a measly 28% eps and FCF growth.  I believe this growth will continue for at least the next 5-7 years, and an investor can realize similar returns in the future since you only have to pay a reasonable 18.5x eps, 16x forward eps, and 14.2x FCF presently.

About the Company

LOGI makes peripheral devices for consumer electronics.  Mice and keyboards are their bread and butter, but they’ve added product lines over the years to now include speakers, webcams, VoIP headsets, game console controllers, universal remotes, and various other products.  Odds are good that you’re using a LOGI product as you read this…check the bottom of that Dell mouse.  Rather than invent the next iPod, LOGI develops products for existing markets that have large total opportunities for some type of peripheral.  They aren’t reliant on a hit product; their best-seller is only 3% of sales.  They have a new state-of-the-art plant in China, and outsource ~50% of their low margin manufacturing to contract manufacturers.  LOGI relies on acquisitions for future growth, and typically makes small (< $50m) investments in emerging technologies, looking out many years.  Most recently they acquired a wireless music system company called SlimDevices and a home security monitoring company called WiLife.  The general theme of the company is that they’re trying to capture the larger shift towards wireless products and digital homes.

Okay, so it’s not a value stock, but there’s a lot to like here.  Management has been impeccable.  The financial results alone back this up, but I am amazed at how they’ve continually managed to position LOGI to be in the right place at the right time.  They acquired Connectix webcam company in 98 before the emergence of broadband.  They bought portable speaker company Labtec 6 months before Apple unveiled the first iPod.  They bought Intrigue Technologies remote company for $30m in 04…this line did $100m in sales last year with ~50% margins, growing +200% annually since the acquisition.  And despite selling products with short life cycles that decline significantly in price, their margins have gone up.  At some point, it’s not an accident – management is just plain better than the competition’s.

LOGI has a surprisingly wide moat, and it exists in several forms.  They’re the market leader in almost category in which they compete, usually with the second place guy way off in the distance.  There have been few, if any new entrants into their markets for a couple reasons.  First, the availability of retail shelf space severely limits a new player.  Second, no one has the cost structure of LOGI.  LOGI’s supply chain, manufacturing capabilities, and customer relationships would almost always render a new entrant less profitable.  Finally, I think most of what LGOI does is simply overlooked…I mean, how many people out there are dying to jump in the mice/keyboard business?

Outside Cupertino, I’m convinced that LOGI has the most innovative and consistent R&D group in the mainstream CE world.  These people have almost single-handedly transformed mice and keyboards from neglected input devices into $100-200 products loaded with inventive features, an incredible coolness factor, and are accessible to the masses.

Their OEM business is actually a competitive advantage, despite being a boring high volume/low margin business.  Even though they’re mostly making keyboards/mice for guys like Dell, Sony and HP, it allows them better pricing power for components (60% of COGS) on the non-OEM side, helping enable their 32-36% gross margin.

Finally, the total opportunity for their products is huge, and LOGI’s sales are not usually governed by how well their primary products (PC’s, notebooks, TV’s, iPods, etc) are selling.  For example, how many notebook computers are already being used that do not have a mouse (personally, I don’t know how anyone uses those track pads, especially if you need to do anything in Excel)?  The number is something like 900 million, and around 125 million new notebooks ship each year.  Or how many people have home entertainment systems and no universal remote?  Who knows, but I feel comfortable saying it’s a lot.  These large install bases mean LOGI’s sales should be relatively smooth, and the results back this up…10 year revenue growth 19.2%, weakest year at ~13%.

Outlook

LOGI’s next order of business is establishing their brand.  Kinda funny to think that they’ve done so well with very little advertising and an unknown consumer brand.  Say the word “Logitech” and most people shrug.  I interpret as an testimony to the quality of their products and a major future opportunity.  I have just recently noticed their first TV ad campaign for their Harmony remotes, which are growing sales +50% and getting rave reviews.  Strengthening their franchise value should help business and justify a premium multiple for the stock. 

No two words make me drool like “operating leverage” and we’re just now starting to see it kick in.  We’re getting improvement on the gross margin side as the product mix shifts towards more higher-end, wireless devices.  More of the portfolio now includes something with either a unique feature or embedded software.  So gross margins use to range between 32-34%, and now we’re starting to see margins consistently in the 34-37% range…a big deal when you’re doing +2b in sales.  The operating margin is also expanding as the company has finally, I believe, hit an inflection point because of their size.  EBIT margins used to be pretty constant between 11-11.5%, but have just begun to expand despite lower revenue growth, to the range of 12-13%.  EBIT margins of 15% by 2011 are not a stretch.

The knock on these guys is pretty simple, often repeated, but has never played out.  “There’s very little IP in most of their products, margins are unsustainably high…keyboards/mice is a crummy business, the good times wont last.”  It reminds me of my business school professors lecturing me on the virtues of efficient market hypothesis.  But why treat a seemingly plausible theory as gospel when there is so much evidence to the contrary?  The products are increasingly complex and differentiated, and new lines are very carefully added.  LOGI keeps cramming more useful features that rely on software into their products, keeping competition at bay and margins high.  Perhaps most importantly, why hasn’t this bear scenario even given a hint of playing itself out yet, wouldn’t it have materialized by now?

Financials

LOGI generates a lot of, in the words of Randy Moss, “straight cash, homey.”  Over 200 products and they had a cash conversion cycle of 35 days last quarter…yikes that’s impressive.  Nevertheless, my model doesn’t give any credit for future working capital improvements.  I am adjusting this year’s EPS to account for a one-time loss on cash equivalents (plenty of info available on this from last conf call).  Headquartered in Switzerland, they enjoy a 12% tax rate.

Valuation

They’re growing eps and FCF by 20-30%.  Margins lead the industry and are expanding.  New hit products (remotes, wireless music) are emerging.  Management is as good as any.  Low teens revenue growth during a horrible environment.  Balance sheet is immaculate.  For all that and more you’re paying a pretty reasonable 14x FCF and 16x forward eps.  This is cheap, on an absolute and relative basis, plain and simple.  Plus, LOGI can easily (and has recently) trade at a silly-high multiple of +30x eps.  My DCF, assuming modest operating leverage and below average revenue growth yields a fair value of $55.  There have been on-and-off rumors over the years that MSFT would buy them as they shift to more hardware and CE to mimic AAPL.

I’m a big believer in this company; my house is littered with LOGI products.  I think the main risk is a stagnation in innovation, but I wouldn’t count on that any time soon.  The "consumer weakness" argument is largely temporary and is already in the stock.  Even in this environment, they're still doing double-digit revenue growth.

Catalyst