Are Investors Out Of Their Skulls to Think Skullcandy Is Worth So Much?

Source: Skullcandy.

Does Apple buying headphone maker Beats Electronics for a rumored $3.2 billion, essentially valuing it at twice its sales, mean Skullcandy , which goes for less than its sales, is undervalued by at least half? Although some analysts have taken that view, I'm not certain it automatically should apply to Skullcandy even if its depressed stock price otherwise makes it an attractive M&A target.

First off, if that is the price Apple is ready to pay for Beats, it sounds like a pretty steep premium simply to regain the "cool" factor it's lost over the past few years. After all, during Beats' last round of financing in September, the headphones maker and music service operator raised $500 million from the Carlyle Group, valuing it around $1 billion or so. So more than triple that amount is a big price tag to be shelling out just months later.

Second, some analysts are left scratching their heads as to why Apple is making this acquisition when they had anticipated the tech giant would go for an on-demand music service to complement iTunes and iRadio. That it went for a hardware company and a service that's similar to what's already in existence is baffling to them. 

More important, however, Skullcandy just doesn't have the same cachet as does Beats, and despite several well-received products like Crush and Air Raid, it's still in the very early innings of a turnaround that has yet to prove it's actually gaining traction. A quarter doesn't make a trend, and there have been plenty of disappointments on the way to losing two-thirds of its value since its 2011 IPO, enough that investors should be wary of getting caught up in any emotional takeover momentum.

As its stock slid, Skullcandy has been a long-rumored M&A target, and though the environment for acquisitions is favorable -- like Apple, companies have lots of cash sitting on the sidelines looking to be spent -- the accessories maker has failed to come through for investors in that venue as well.

That could be because revenue growth isn't nearly the same as it once was, from a near-50% high in 2009 to an anemic 7% to 8% this year and next. Operating earnings, as well, were at best just incrementally higher last year compared to the year before. While bulls may argue the company is in repair mode, it should've worked out the kinks before going public. A highly competitive marketplace isn't where you should be getting your business right, suggesting Skullcandy wasn't ready for prime time when it did its original offering.

Although that makes the case for a buyout being Skullcandy's best option, it doesn't argue for one actually materializing -- or if an offer does pop up, that it will be at such a premium. It's further rumored that Apple wanted Beats for the marketing and branding halo effect it could provide, that CEO Jimmy Iovine alone is worth the billions about to be paid out. Perhaps, but Skullcandy seriously lacks in that department as well. There's no must-have name to acquire, and while many contend its products are even better than Beats' in many respects, Skullcandy is a distant second in the court of public perception, and as perception is often reality, demand for an acquisition may not be there.

Skullcandy's boat was lifted by the rising tide of takeover rumor, but it's still a leaky craft and investors would do better watching how it works out its problems rather than hoping they can get bailed out by a deep-pocketed partner.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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