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Taser investors could get zapped again
When stocks are priced for perfection, anything but perfect is trouble. Taser International faces slowing growth and potential competitors -- good reasons to be wary.
By Robert Walberg
One lesson investors never seem to learn is that a good story doesn't necessarily make a good stock. Taser International is simply the most recent example.
The stock of this stun-gun manufacturer has been one of Wall Street's darlings over the past two years, rallying from a split-adjusted 30 cents to an intraday high on Dec. 30 of $33.45. Spectacular rallies such as these can seduce just about anyone.
Unfortunately, if you were seduced by the Taser story a few weeks ago, you must be feeling stunned now because the stock has lost more than 44% of its value.
That's the problem with story stocks: They're supported more by hype than fundamentals. When the hype dies down or the news cycle suddenly shifts, the bottom can -- and usually does -- fall out.
Don't get me wrong. Taser (TASR, news, msgs) has a solid business as the nation's leading provider of stun guns -- or "less lethal self-defense devices." Demand for its weapons has exploded over the past couple of years; nearly 6,000 police departments around the globe have purchased Taser devices. Revenues surged to an estimated $69 million last year from $9.8 million in 2002 (year-end results are due Feb. 8).
Unsustainable growth
But from an investment standpoint, such hypergrowth brings with it a couple of inevitable problems. - The growth rate is unsustainable. The bigger a company gets, the tougher it is to replicate early growth rates.
- Growth like this draws the attention of others, namely competitors. This is potentially much more problematic. Increased competition often translates into reduced market share and lower profit margins. Over the past 12 months, Taser has enjoyed operating margins of nearly 47%, which might prove tough to defend amid heightened competition.
Both of these issues have begun to surface in recent weeks and put pressure on Taser's stock. Though the company is expected to hit its fourth-quarter sales target, it will do so largely because of a large, last-minute sale to Davidson's, a major firearms distributor. The timing of the transaction drew the attention of the Securities and Exchange Commission, which launched an inquiry.
Without the Davidson's sale, Taser would most likely have missed its target, a big no-no for a hypergrowth stock. But let's put these channel-stuffing concerns aside for a moment and focus on the bigger picture. Sequential revenue growth is slowing. These are the quarter-to-quarter sales growth rates over the past six quarters: 24%, 45%, 77%, 21%, 24% and 16%. If the company delivers on expectations and posts fourth-quarter sales of $20.8 million, growth will have slowed even further to 10%.
Slowing down
Now, 10% sequential growth is nothing to sneeze at. It is not 24%, however, and it's a far cry from 77%. As Taser's sales growth inevitably slows, the price-to-sales multiple must also shrink. Considering that Taser still trades at 19 times trailing 12-month sales, there's plenty of room for further shrinkage.
While multiples are contracting, competition is expanding. Helping the competition are recent safety concerns surrounding Taser's stun guns. The weapons are designed to deliver a temporarily disabling electric shock to a person that affords law enforcement officials, prison guards and/or soldiers the opportunity to subdue the victim. However, there have been several claims that the shock can be deadly, especially to people with heart trouble.
The company has repeatedly cited studies showing the safety of the product, but these studies and the company's veracity are now being questioned by shareholders as well as government officials. In fact, this is another concern being investigated by the SEC.
But more problematic than the SEC inquiry is the fact that the safety issue is compelling potential clients to look more closely at competitive offerings. Just last Friday, the city council in Chicago passed a resolution to hold hearings on alternate devices, such as Universal Guardian Holding's (UGHO, news, msgs) Cobra StunLight pepper-spray product.
Stinger Systems (STIY, news, msgs) and Law Enforcement Associates (LENF, news, msgs) also recently announced that they would begin production of competitive products.
All three competitors, however, are quite small. It's the mere threat, rather than the reality of competition, that's depressing Taser's stock.
Getting creamed
Again, that's the inherent risk of buying stocks based on the story over substance. If something crops up to change the Street's perception of the story, even if only temporarily, the stock can get creamed.
This isn't the first such decline for Taser. The stock suffered a similar news-related collapse in April 2004, only to climb to new highs by year-end.
When stocks are priced for perfection, anything but perfect is trouble. Taser now faces legitimate questions about its sales practices as well as the efficacy of its safety claims. Equally as important, however, the company is suffering through the usual growth pains of a hypergrowth stock: Sales growth is slowing, and competition is heating up. Put simply, Taser was an outrageously priced stock poised for a tumble.
Even after the recent 40% drubbing, the stock still is trading on a whole lot of optimism. For argument's sake, let's assume that Taser grows sales by an annual average of 40% over the next three years. That would place sales at about $188 million in 2007. At today's price, that would leave the stock trading at about six times sales. Maybe you wouldn't call that outrageous, but it certainly isn't cheap given that we're talking 36 months out and assuming a generous 40% growth rate.
Big assumptions
Now let's look at the multiple to earnings. The stock trades at 42 times estimated 2005 earnings of 47 cents a share. Assuming earnings-per-share growth of 30% a year for the two years after that, Taser would be earning about 80 cents in 2007, leaving the stock trading at 25 times projected results. That's not bad for a company growing by 30%, but that's still three years out and assumes no change in the stock price.
In other words, if the stock trades sideways for three years, it would still sport mid-to-high multiples based on optimistic forecasts. Maybe that's why managers have been busy selling shares of the stock in recent months. They can cite diversification of their assets all they want as reasons for selling, but the truth of the matter is, who can blame them for selling shares in an overpriced asset? They didn't get to where they are by being stupid and holding on to an inflated asset, no matter how promising the story.
Taser's precipitous price drop in early 2005 has raised plenty of questions about the company's near- and long-term outlooks. While it's important to get the answers to the questions about alleged channel-stuffing and safety, you don't have to wait for the answer to whether Taser represents a good value at today's price.
That answer is "no." Growth is slowing, competition is increasing and valuations are contracting. This combination is the investment equivalent of an electric shock that should stop you in your tracks.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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