NOTE TO EDITORS: The Following is an Investment Opinion Issued by Spruce Point Capital Management
Believes That Zebra Is Downplaying Competitive Pressures Across Its Core Hardware, Services and Software Offerings, and May Be Embellishing Market Leadership Claims
Highlights How Zebra is Not Adequately Addressing a Variety of Trends and Factors Working Against the Company
Outlines Why Zebra’s $2.1 Billion Levered Acquisition Spree and Venture Investments – Which Expanded Its Offerings into Analytics, Robotics, and Machine Vision – Should be Characterized as Failures
Expresses Concerns About Multiple Accounting and Financial Reporting Choices Made by Zebra Given That It Describes Its Chief Accounting Officer as Comfortable Operating in Gray Areas
Questions Management’s Alignment With, and the Board’s Commitment To, Shareholders
Estimates That a Sum-of-Parts Illustrative Valuation of Zebra’s Business Suggests That the Share Price Could Be Overvalued and Have 65% – 80% Long-Term Downside Potential Risk
Founded in 1969 and based in Lincolnshire, IL, Zebra designs, manufactures, and sells a broad range of automatic identification and data capture (“AIDC”) products, including mobile computers, barcode scanners and imagers, radio frequency identification (“RFID”) readers, specialty printers for barcode labeling and personal identification, real-time location systems (“RTLS”) and other related accessories, supplies and software applications. Through recent acquisitions, Zebra now also provides machine vision and robotics automation solutions and services. The Company’s operations consist of two reportable segments that provide complementary offerings to its customers: Asset Intelligence & Tracking (“AIT”) and Enterprise Visibility & Mobility (“EVM”). As of the trailing 12 months ended June 30, 2024, the Company reported $4,357 million and $230 million of revenues and net income, respectively.
The concerns we outline in our report include:
- We believe there is evidence that Zebra’s recent poor financial results are more than just temporary and are not simply market-wide issues, as claimed by management.
- Zebra’s recent statement that “the competitive environment hasn’t changed a lot overall” merits scrutiny.
- Zebra was a COVID-19 beneficiary at a time when companies invested heavily in supply chain improvements. However, despite this benefit, we found that from 2019 to 2023, Zebra’s annual hardware sales growth (80% of total sales) averaged only 1.3%, which includes price increases and M&A. Additionally, over the same period hardware margins have contracted by 360 basis points. While Zebra’s services and software revenue (20% of total revenue) has been a bright spot, growth has decelerated to low single digits and the Company’s margins are at approximately 52% - which is a far cry from a typical SaaS company that has margins in the 70% range. Overall, we believe Zebra’s innovation edge is in jeopardy, evidenced by its decline in R&D expense and engineering headcount, decline in trademarks, patent growth deceleration and a marked slowdown of new venture investments.
- Zebra’s claim that it has #1 market share positions in various categories also merits scrutiny.
- Zebra has long promoted RFID technology as a big opportunity, but we believe that its leadership is now being challenged by faster-growing total solution providers, such as Impinj Inc. (Nasdaq: PI). In fact, Zebra recently made subtle changes to its #1 market leadership claims in RFID and barcode printing. It even sourced a research firm (to which it is a client) to support these claims, which raises concerns about objectivity. Our research indicates that Zebra benefited from early adoption of Android operating systems and was insulated at the low-end of the market from competition. However, competition has since caught up. Low-priced Chinese competitors have entered the market, and more companies now allow employees to use their own smart phones in lieu of Zebra devices.
- Zebra may potentially be downplaying its large exposure to the retail and apparel industry, where certain clients are experiencing pressures.
- At a recent March 2024 investor conference, when Zebra’s CFO was asked about their market exposure, he said that retail is 30% of revenue but down from 40% of revenue. What’s concerning about this statement is that he did not specify over what time period revenue was down. Zebra does not regularly report revenues by industry verticals, but from time-to-time provides a pie chart depiction of sales by vertical without exact percentages. In fact, we see that Zebra has provided a nearly identical pie chart over the last four years which suggests that its exposure to retail may not have decreased at all.
- Zebra has also publicly acknowledged that Walgreens is one of its deepest services partnerships in the retail sector, which is troubling given Walgreen’s business struggles.
- On June 24, 2024, Zebra issued a press release (our underlined emphasis) saying that, “Walgreens Saves Millions of Dollars by Optimizing Store Operations with Zebra’s Workcloud Software.” The press release was retracted and replaced with a revised announcement that “Walgreens Saves Millions and Optimizes Customer Experience Using Workcloud Actionable Intelligence.” Walgreens also retracted a quote referencing, “Zebra’s leading-edge software and hardware solutions.”
- Zebra’s leveraged acquisition spree and venture investments could be characterized as expensive failures.
- Since 2019, Zebra has completed eight deals for $2.1 billion.
- Zebra acquired ~$243 million in revenues and paid an average multiple of 8.8x revenues. In the process, it incurred ~$100 million in transaction costs and doubled leverage from 1.5x to 2.7x Net Debt / EBITDA. We believe that deals, such its 2021 acquisition of Fetch Robotics for $301 million, are falling materially short of plans to expand into warehouse automation. On top of that, it recently discontinued a key product and provided no concrete update about the business when asked twice by analysts on its recent Q2 2024 conference call. Also in 2021, Zebra acquired Antuit.ai (“Antuit”) for $145 million claiming it to be a fast-growing AI-powered SaaS retail analytics company with high margins. However, after obtaining Antuit’s financial filings from Singapore, we find that its revenue growth flatlined a year before being acquired, and its gross margins were ~20% below typical SaaS companies. Lastly, in 2022 Zebra acquired Matrox Imaging (“Matrox”) for $881 million to expand into industrial automation and vision technology. However, a former executive commented that product cycles are up to 20 years long, the acquisition has fallen short of plan, and Zebra later admitted that semiconductor clients amounting to 50% of revenues have curtailed purchases. Growth opportunities in electronic vehicle manufacturing are also unlikely to materialize as planned since consumer demand has waned and manufacturers have delayed capex expansion. Moreover, Zerba is still recording acquisition and integration expenses more than two years after acquiring Matrox.
- We have a negative view of public companies acting like venture capitalists.
- Zebra has a venture fund which started making venture investments as early as 2012. It is our general opinion that if a public company needs to incubate new business ventures with speculative chances in order to succeed, it is a signal that the company is mature, lacking innovation, or finding acquisitions difficult. To test this theory, we analyzed Zebra’s venture investments and observed that its venture investment activity declined along with its ability to harvest gains. The carrying value of its investment portfolio was stable since 2022 but declined in Q2 2024, resulting in a recorded loss of $6 million. We also question if an interpretation of a recent accounting change in 2018 enabled Zebra to delay impairment of venture investments. By using LinkedIn Premium for directional indicators of the growth of Zebra’s fourteen venture-backed private companies, we find that at least eight of these companies have shown contracting employment growth.
- Considering Zebra’s liberal accounting policies and recently disclosed inventory reclassifications, investors should be unnerved that Zebra describes its Chief Accounting Officer (“CAO”) as being comfortable operating in “Gray Areas.”
- We find evidence that Zebra struggles with its inventory accounting, which is ironic given that it sells solutions to help customers track assets.
- Starting in 2023, Zebra’s year-ending inventory balance relative to its next 12 months of forward projected sales was elevated at a multi-year high. Zebra is reliant on distribution and channel partners, and for at least nine years, has consistently said that it has more than 10,000 partners. While this may be true, our research indicates that the total number of partners has been declining. Zebra recently modified its inventory accounting policy language and disclosed a reclassification of its 2022 inventory results, which moved $76 million from raw materials to finished goods. We find it perplexing that Zebra could confuse what a raw material is versus a finished good. Zebra’s segment reporting methodology was revised in the past to correct inaccuracies and to simplistically allocate depreciation and share-based compensation as a percentage of sales. In addition, Zebra frequently reclassifies products among its two segments and recently disclosed inventory-related charges in both segments without specifically quantifying the impact for investors to analyze.
- Zebra’s Chief Accounting Officer (“CAO”) should concern investors.
- Investors should be on red alert that Zebra’s CAO worked at Perdoceo Education Corp. (Nasdaq: PRDO, formerly Career Education Corp.) (“CEC”) as CFO and CAO during a period of intense scrutiny by the federal government. CEC ultimately settled with the New York State Attorney General over allegations of inflated and inaccurate reporting in an agreement where it paid $9.25 million in restitution. Zebra describes its CAO as “not afraid to operate in gray areas” and as someone who is “identifying areas where we can tailor accounting practices to our business processes versus having to re-engineer business processes.” Moreover, the CAO claims to be a CPA. However, a check of the Illinois Department of Financial and Professional Regulations indicates that her license has not been renewed since 2003.
- Zebra’s recent appointment of Board member Ken Miller to its Audit Committee is noteworthy and highly concerning.
- On May 15, 2024, Zebra appointed Ken Miller to its Audit Committee. Mr. Miller was previously an executive at Juniper Networks (“Juniper”). According to the press release on his appointment to the Zebra Board, he joined Juniper in 1999 and held a variety of roles there during his tenure. In fact, he held multiple senior corporate accounting and reporting roles during a period in which Juniper restated its financials after the Audit Committee, with the help of forensic accountants, analyzed its options pricing practices. Furthermore, in 2019 while Mr. Miller was Juniper’s CFO, it settled Foreign Corrupt Practices Act charges with the SEC.
- There are growing signs of misalignment between management, the Board and shareholders.
- Spruce Point believes that Zebra urgently needs a refresh at the Board level.
- We are concerned that 50% of the Board has been entrenched for over a decade, with Directors Maniere and Smith having served for over two decades. Zebra’s Board is also classified, which makes it more difficult for investors to enact changes. In addition, Zebra’s CEO Bill Burns recently joined the Board of Oshkosh Corp. (NYSE: OSK), which we think will be a distraction that will drain his time and pull his attention away from solving Zebra’s problems. We also believe investors should be alarmed that despite leaving Zebra in a poor financial situation, outgoing CEO Anders Gustafsson received a generous $9.0 million restricted stock grant in 2023 with just a one-year vesting period as he transitioned to Executive Chair. Moreover, Gustafsson faced previous allegations of bad financial management through shareholder litigation while serving on the Finance Committee of Dycom Industries Inc. (NYSE: DY) (“Dycom”) in the 2017-18 period. Dycom eventually settled the shareholder litigation. We also observe a troubling trend of what appears to be less Board engagement. Despite 2023 being a challenging year, Zebra’s Board only met five times, which was a large decrease from prior years when they met between eight to ten times. In the past decade, Zebra’s insider ownership has plummeted from 6.5% to just 1% of the equity.
- Zebra’s multiple expansions and valuation premium to the sum-of-parts are difficult to explain. As a result, we estimate 65% – 80% long-term potential downside risk to the share price and believe the share price is likely to underperform the market.
- Zebra’s long-term organic revenue growth objective of 5% – 7% appears ambitious, given recent results and our research findings.
- Zebra’s most bullish sell-side promoters are a chorus of smaller brokers and appear convinced of management’s claims. In total, sell-side analysts are divided in their share price opinions and the average consensus price target is $365 per share. Spruce Point believes the analysts have failed to conduct a rigorous forensic analysis, which would point to growing pressures across Zebra’s core business as well as its recently acquired “growth” segments. Yet, Zebra’s NTM revenue valuation multiple has expanded from 2.8x to 3.7x since 2019 despite our findings that between 2019-2023 annual hardware sales growth (inclusive of price increases and M&A) has been just 1.3% and margins have contracted 360 basis points.
- Despite the fact that Zebra has expanded its services and software margin recently, its growth rate has been rapidly declining and is now low single digits and is inappropriately valued.
- Zebra also has large exposure to the retail and apparel industry, which it has made potentially conflicting representations about. As discussed above, we have determined that the Company has exposure to Walgreens, which is beleaguered and is reducing its physical footprint. Furthermore, we value Zebra’s struggling RFID business and acquired “growth” revenue from acquisitions separately and argue they should be valued at a discount to peers. While management has done a good job controlling costs and enacting frequent restructuring programs in response to declining revenues, we find that its side-effect is a corporate culture that bemoans low-median wages below public company peers. In a tight labor workforce where wages are a lever that companies can use to attract and retain employees, Zebra may have a difficult time competing. Based on our sum-of-parts potential valuation, we estimate a long-term share price range of $62.90 – $110.00 (65% – 80% downside risk). We expect Zebra to underperform in the technology sector along with the broader equity market.
