More than one Way to Skin an Apple

By Peter Pham - June 4, 2012 | Tickers: AAPL, CMGE, ZAGG | 0 Comments

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Any fashionista will tell you that the key to a great outfit is great accessories. Be it themselves, a pet, their car or a phone, people love to dress stuff up. ABI Research estimates that global revenue from aftermarket accessories sales will be in excess of $50 billion by 2015.

A major player in the space, ZAGG Inc (NASDAQ: ZAGG), earned revenues of $179 million in 2011 from sales of iPhone and iPad screen protectors, cases and accessories, up from $76 million the previous year. In the past two years Zagg’s stock has outpaced even the vaunted Apple 349% versus 126%. Estimates are that nearly half of those sales are of screen protectors alone, with covers and other accessories making up the balance.

Prior to the release of the iPod in 2001 the device accessory market was fractured among many device makers and models. The rise in popularity of Apple (NASDAQ: AAPL) products helped focus the market to a narrower product range and provided a more or less guaranteed market for manufacturers. New cottage industries sprung up to fill the demand, as consumers were more than happy to shell out a few extra dollars to protect and decorate their beloved iStuff.  A low barrier to entry and blood in the water created a feeding frenzy, as new players got into the device accessory business, offering consumers more choice and better prices.

As of 2011, US sales of screen covers and accessories accounted for 88% of Zagg’s revenue. In an already crowded space and increasingly saturated market, the question is where is Zagg’s future growth coming from?  The obvious answer, as it so often seems to be these days, is Asia. Large populations, growing fortunes and an increasing hunger for the new and the cool, have made Asia an attractive, fertile new frontier.

Asia calling

The aforementioned low barrier to entry for manufacturing device accessories reveals itself most clearly in Asia, where mobile accessorizing is taken very seriously. The choices are many, and they are cheap.

Here in Asia, where kitsch is king, mom and pop shops on virtually every street overflow with the latest, brightest and loudest gadget add-ons, ringtones, cases, lanyards and other assorted vanity items. Products on offer range from the handmade and gaudy, to knock-offs of established luxury brands.  In fact, most of the products that end up on US shelves were most likely made right here, possibly in the same factories as the products that show up in the local marketplace.

So here we have a massive market hungry for Apple gear, but with an already saturated accessories market, making competition on price particularly challenging.

Brand on the run

As more and more people join the ranks of the middle class and nouveau riche throughout Asia, brand awareness is increasingly becoming a feature of daily life. Especially in Vietnam and China, where decades of depravation and struggle coupled with recent newfound wealth and increasing options have created a tsunami of demand for the good life. For people who have always had to make do with cheap products, the urge to have the real thing is often hard to resist. When dressing for success imitation knock-offs are strictly a no-no.

But with no real brand equity or product differentiation, the challenge for Zagg and other players will be to find a niche where they can stand out in a market framed on one side by cheap off-brand products and on the other by established high end brands. A real worry is the year over year margin contraction from 12.3% to 9.2%, which may be from this form of attrition.

Zagg has hitched its wagon to Apple and the strategy has worked well for them thus far, but they may find Asia to be a difficult market for them to follow Apple into. Apple has unrivaled brand power and a product that is highly differentiated and not easily copied. People buy Apple precisely because it is Apple. Not so Zagg merchandise. This symbiotic partnership is reflected in the stock performances of Zagg and Apple. As goes Apple’s stock, so goes Zagg’s. The performance of the stocks of both companies show a correlation between the Apple’s rise and Zagg’s good fortunes.

Zagg stock currently trades at a P/E of 15.1, similar to Apple’s 13.7.  The projected P/E of 9.9 and the iPhone 5 just around the corner means that as long as there is not a crash in U.S. equities, Zagg’s current price around $10.50 per share looks attractive.  

Clearly this is a relationship that Zagg management and shareholders alike would like to see continue and grow.  So what is the way forward in this increasingly ripening Asian market? Special branded or logo-printed gear, such as the Zagg Sport Leather line featuring logos of NBA teams will help their entrance into niche, focused specialty markets where a combination of good product design and brand cache could make for a winning partnership and create pricing power.

With the U.S. economy still dragging along and older iPhones becoming affordable to lower end consumers there, Zagg might be able to squeeze more share of that growing market, but the real growth is in Asia. Apple knows this, and is currently in talks with China Mobile (NYSE: CHL) and their near 700 million subscribers to make the iPhone available to their subscribers, a move that would accelerate iPhone adoption in that market. The revenue potential for such a partnership could be epic.

Zagg must find an angle of attack to gain entrance this market or risk being left behind the velvet rope. People are going to keep buying Apple products, and people are going to keep dressing them up. Zagg needs to make sure that they’re doing it with their products. 

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