Mellanox Technologies (MLNX) supplies high-performance, end-to-end interconnect solutions for data center servers and storage systems. Mellanox was halted after market close yesterday, January 2nd, 2013. Mellanox had already guided expectations for the fourth quarter lower during its third quarter earnings release on October 17th, 2012. Yesterday's guidance was the second reset. The October projections were $145-$150M as compared to expectations of $157M - an 8% decrease at most. Yesterday's guidance dropped to $119-$121M for an overall decrease of about 24%. Between October 17th and January 2nd, the stock price dropped from $98.15 to $61.19, a 37.5% decrease. After hours on the 2nd, the stock price dropped another 13.87% to $52.70.
Taken in isolation, the numbers are dramatic, even troubling. But, looking at Mellanox's recent history and stock performance, the reset isn't as disconcerting. Year-over-year quarterly EPS growth as of the third quarter was 906% while year-over-year revenue growth was 130%. Mellanox's 52-week range in 2012 was from $30.00 on January 23, 2012 to $120.05 on September 6, 2012. Mellanox had $380M in cash as of third quarter reporting and only $4M in debt. 2012 revenue is now projected at $500M, a 93% increase over 2011 revenue of $259M. Previous expectations were $527M for a 103% increase. Overall, the YOY annual increase only lost 10 points.
Such rapid and dramatic growth is just not sustainable. There will be hiccups, pull-backs and retracements. After the sharp climb from $43.33 to $65.91 on April 19th, the low on May 18th, 2012 was $53.29. An uptrend continued until September 6th when the stock reversed into a downhill slide. Mellanox is at May levels again. Yet, even the low-$50 level represents a 60% increase from the onset of 2012.
Additionally, of the $26-$29M shortfall announced yesterday, the majority is due to a technical issue with FDR 56Gb/s InfiniBand cabling that delayed $20M in deployments. Mellanox assured in its press release the cabling issue is resolved and is not expected to impact future revenues.
Mellanox is holding a conference call on January 3rd at 8:30 a.m. ET. Pending further explanation, some numbers can be extrapolated for consideration. Year-to-date EPS through the third quarter is $2.21. Using the historical 21.62% profit margin, EPS based on $119M revenue for the fourth quarter would result in EPS of $0.61. That puts the 2012 annual EPS at $2.82. The 2011 annual EPS was $1.07. While 2012 estimations were at $3.93, even at $2.82, the YOY increase would be 164%.
Now, assuming the $20M delayed deployments are pushed into 2013, the 2013 estimates increase to $658M in revenues and $4.27 EPS. Percentage increases for 2013 would then equate to a 32% revenue increase and a 51% EPS increase. Current five-year EPS growth estimates are a staggering 74% which puts YPEG results at $315.98 (74*4.27).
However, it may be more practical to use more conservative yet historically-proven factors in the calculations. For example, using the 21.62% trailing twelve months' profit margin, if revenues increase to $658M, EPS for 2013 equates to $3.36. Using the past five-year EPS growth rate of 25.18% and conservative EPS 2013 estimate of $3.36, YPEG results at $84.60. Based on that and the after-hours drop in price to $52.70, Mellanox would be considered undervalued by 60%.
Mellanox has a solid balance sheet and cash position. Mellanox is still situated in a steep growth trajectory. At its Analyst Day in October, 2012, Mellanox estimated the 2012 interconnect market at 13.2M points and $5.3B growing to 15.1M points and thus $6.04B in 2014. Based on those estimates, Mellanox currently has just 10% market penetration. Compared to an aggressively-paced YPEG of almost $316, the September high of $120 was a gift. Based on a conservative YPEG of almost $85, the September high of $120 was ahead of itself. Based on any share price in the $50-$60 range, Mellanox looks like a strong candidate to buy and hold if an investor can stay mellow through some growing pains.