Logitech's Music Business Sings

This column was originally published on RealMoney on Aug. 3 at 11:28 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.

It seems like tech investors who are out to capitalize on the growth in digital music are focused primarily on iPod-maker Apple (AAPL) and chipmakers SigmaTel(SGTL) and PortalPlayer(PLAY). But Switzerland-based Logitech (LOGI), best known for its line of PC keyboards and mice, has been building up its exposure to digital music, a trend that should send the stock higher over the next 18 months.

Analysts are now forecasting a 17% growth rate in earnings for Logitech over the next two years, but that number could be on the low side as Logitech's exposure to the high-growth music market should allow it to continue beating estimates. Plus, even after the 30% rally in the stock since the end of May, shares are trading at just 22 times expected calendar-year 2005 earnings of $1.74 a share, a reasonable number for a company with increasing exposure to a high-growth market and superior fundamentals.

Logitech's June-quarter audio product sales (consisting of speaker systems and headphones) grew 155% year over year to a record $55 million, or 16% of sales. Unit shipments grew by only 79%, implying a shift to higher-priced products; this is unusual, since consumer technology companies tend to experience falling selling prices over time. These numbers bested the company's results during last year's Christmas season and represent an acceleration in growth, as fiscal 2005 (the company operates on a March fiscal year) audio product sales were $158 million, or 11% of sales, growing only 33% over 2004.

While 16% of sales may not seem like much, Needham analyst Charles Wolf noted in his recent upgrade of the stock to a buy that digital music could be a key driver of revenue growth acceleration at Logitech, as the market is in its early stages. Wolf sees the installed base of portable music players growing fivefold by 2010, to 500 million units, and he believes Logitech's trusted brand will enable it to capture a material share of the market.

For reference, the company's total June-quarter sales were $335 million, or 26% higher year over year, and earnings per share were 23 cents vs. 19 cents last year. Both numbers compared favorably with analyst expectations of earnings per share of 22 cents on $308 million in sales. Outside of the audio business, keyboard and mice sales grew 10% to $147 million, Web-cam product sales rose 6% to $48 million, and gaming product sales rose 27% to $21 million. Also, the OEM business, in which Logitech makes keyboards and mice for PC manufacturers, grew 17% to $50 million.