iRobot Short Looks at Accounting Issues, Insider Selling, Industry Hype

iRobot (Nasdaq: IRBT) has seen its stock rise irrationally due to investor speculation of a “Robotics Revolution,” caused by media, analyst, and investor hype over small investments by companies such as Google (GOOG) and Amazon (AMZN) in robotics. In reality, we believe IRBT is a struggling consumer product company whose dominance in the home vacuum market is now in question, from powerful macro housing changes, and the proliferation of cheaper competitive products. The company appears to be scrambling to forestall its problems with aggressive and opaque accounting gimmicks, by diverting attention to its “Formidable IP Portfolio,” touting a large and global addressable market opportunity, and trumpeting its “Growth Opportunities” in the enterprise and health telepresence markets (which are years away from commercialization and presented to investors with dubious misinformation).

However, there are more pernicious and glaring signs that IRBT is no longer a growth company, but more likely a mature company with its best days behind it. We observe that insiders are milking existing cash flows through outrageous compensation schemes, and with intensifying and persistent insider sales. To keep its stock elevated, IRBT also appears to be using aggressive accounting techniques to prevent the unraveling of its financials, but its balance sheet is showing ominous signs that it may be stuffing the channel (Days Sales Outstanding and Days Sales in Inventory are exploding). We also observe that IRBT has dramatically ramped up its sales and marketing above the level of R&D expenditures, which begs the question: is IRBT still a technology innovator with a defensible moat, or a struggling consumer product marketing company?

Furthermore, IRBT has accelerated its investor marketing campaigns in 2014 in an effort to convince investors and sell-side analysts that its future is bright. The sell-side analyst community has embraced the story and given its shares numerous buy recommendations, and an average price target of $44/share (implying +35% upside). IRBT is quick to compare itself to the likes of 3D Systems (DDD), Garmin (GRMN), Trimble (TRMB), Synaptics (SYNA), and Dolby Systems (DLB) - (companies with enterprise values 5x its own and valuations of 4x sales) - in hopes of justifying its share price expansion. In our opinion, IRBT is richly valued at 9.5x ‘15E EBITDA and 1.3x ‘15E revenues, and at high risk of not achieving analyst expectations. Further, we believe IRBT should be viewed as a narrowly focused consumer product company such as Sodastream (SODA), Leapfog (LF), Skullcandy (SKUL), NetGear (NTGR) and Select Comfort (SCSS), and that our governance and accounting concerns are not discounted into the current share price.

We estimate IRBT’s intrinsic value to be $20 - $25/share (25-40% downside), implying a valuation on 2015 street estimates at the midpoint of 16x, 6x, 0.8x – EPS, EBITDA and revenues, respectively. Our valuation assumes street estimates are achieved (unlikely in our view), and even incorporates an overly generous value for its patent portfolio. We note that IRBT has spent a negligible amount of money to defend its patents, and has never found a way to monetize its portfolio. However, using a rule of thumb that patents may be worth 5-10% of an addressable market value (in this case IRBT’s patents are heavily weighted toward the robotic vacuum market), we derive an optimistic valuation range $50 - $100m, or $1.60 - $3.20 per share for its patents.

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