Mellanox - Outlook Continues To Be Uncertain

Jan. 3.13 | About: Mellanox Technologies, (MLNX)

Shares of Mellanox (MLNX) fell 14% in after hours trading on Wednesday. The fabless semiconductor company issued a downbeat outlook for the fourth quarter of 2012.

Fourth Quarter Outlook

Mellanox issued a very weak outlook for the fourth quarter of 2012. The supplier of high performance and end-to-end interconnect solutions guides for fourth quarter revenues of $119-$121 million. This is far below the previous outlook of $145 to $150 million.

At the midpoint of the guidance, revenues are expected to fall more than 23% compared to third quarter earnings. Revenues are up 65% compared to fourth quarter revenues of 2011.

Mellanox blames the shortfall on weaker demand, challenging macro-economic conditions and a technical issue with the FDR 56Gb/s InfiniBand cabling, delaying $20 million worth of revenues.

The company guides for fourth quarter non-GAAP gross margins of 68.5 to 69.5%.

Valuation

Mellanox ended its third quarter with $397.7 million in cash, equivalents and short-term investments. The company operates with negligible amounts of capital lease obligations of $4.4 million, for a net cash position of $393.3 million.

For the first nine months of 2012, the company generated revenues of $378.7 million, more than double the amount of 2011. The company reported a net income of $92.9 million, or $2.13 per diluted share. The company is on track to generate annual revenues of $500 million on which it could earn $100-$120 million.

Factoring in a 14% decline in after hours trading, the market values Mellanox at roughly $2.24 billion. This values the operating assets of the firm at $1.85 billion, which values the firm at 3.7 times annual revenues and 16-17 times annual earnings.

Mellanox currently does not pay a dividend.

Some Historical Perspective

Shares of Mellanox have seen a great deal of movement over the past trading year. Shares rose from $33 at the start of 2012 and rose to highs of $120 in September of the year on the back of accelerating revenue and earnings growth. Shares have lost more than half of their value from that point in time, trading at $53 per share at the moment.

Long-term holders are still trading with large gains. Shares rose from $8 in 2009 to all time highs in 2012. Between 2008 and 2012, Mellanox increased its annual revenues from $108 million to an estimated $500 million. The company has been profitable over the time period, reporting historically strong profits in 2012.

Investment Thesis

Shareholders in Mellanox have seen great returns in recent times, driven by the acceleration of the operating performance. Shares have fallen back significantly, reaching lows of $49 per share in after-hours trading, marking losses of 60% from September's all-time highs.

The poor guidance has been mainly attributable to the technical issue with the FDR 56 Gb/s InfiniBand cabling, which caused $20 million worth of revenues to be delayed. Excluding this delay, revenues are expected to come in between $139 and $141 million which is below the company's own guidance of $145-$150 million and analysts' estimates of $148.3 million.

I refrain from making an investment in Mellanox. While the valuation has become rapidly more appealing after recent declines, I am even more worried about the impact of competition. Mellanox currently dominates the market for high-speed InfiniBand products. Last year, Intel Corporation (INTC) bought the InfiniBand activities of QLogic (QLGC) in a $125 million deal. Intel has sufficient financial resources and has announced its ambitions in the field, thereby threatening the dominant position of Mellanox.

The niche market for super high-speed data communication products continues to grow with the cloud boom, but it also attracts competition. I remain on the sidelines given the uncertain impact on the operational performance of the firm.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.