Fusion-io (FIO) is down nearly 50% since its recent high north of $32 in October of 2012. So is now the time to take a long-term position in the stock?
While the chart may look enticing, this latest downward movement is warranted. The company expects less sales in the March and June quarters from strategic customers Facebook and Apple (34% and 16% of revenue respectively). FIO is a victim of their own success. While they were lucky enough to gain great relationships with these customers, they have become such a large part of their business that a delay in buying (let alone a loss of business) has a serious effect of their income statement. Fusion-io is doing its best to diversify its revenue base but given the size and growth of its strategic customers, this will be no easy feat.
These events put into question if Fusion-io should be a long-term holding in your portfolio. As always, this question leads back to the long-term competitive advantage (or the lack thereof) of the business.
When looking at Fusion-io, one must first understand the basics of what they actually do. In its most simple terms, FIO is a play on the trend of storage conversion from hard disk drives to solid state drives (flash memory). Solid state drives have immediate start-up, are more energy efficient, faster, and they do not have any movable components, making them less breakable. Because of these qualities, flash memory has been utilized in many different applications. On the retail consumer side, flash is great for small devices like cell phones and iPods. On the enterprise side, it is used in data centers for the storage of data that needs to be accessed at very high speeds. This is where FIO comes in.
Fusion-io has created a flash-based storage solution for enterprises that offers greater speed and reliability than traditional hard disk drives. While the cost per gigabyte of storage is still well above that of traditional hard drives, Fusion-io's products are useful for certain applications that require much faster speeds than hard disks will allow.
However, flash memory is a commodity. So, Fusion-io has gone a step further to differentiate itself in hopes of creating a moat. Below is a diagram from the company website that entails its approach.
Essentially, the company uses software, known as the Virtual Storage Layer, to cut out some of the clutter that other SSD's rely on. The RAID controller depicted on the left creates a bottleneck in the storage retrieval process, causing a slowdown in data transfer. The VSL implemented by FIO gets rid of this bottleneck and brings the flash memory closer to the CPU; ultimately lowering latency. The company has 120 patents around this process as well as 100 more that are pending.
However, competition continues to brew. Seagate (STX) recently purchased a stake in Virident, a competitor in the space. With investment from a much larger organization, Virident will have more resources to compete against Fusion-io despite the patent protection. FIO has stated that Virident's process is not as reliable and not proven at scale, but I think it is only a matter of time until Virident (and others) make a comparable product. I compare this industry to the infancy of hard disk drives. At one point, there were 90+ hard drive producers. However, do to the economics of commodities and scale advantages, the industry has consolidated down to three main players. Many hard-drive producers went out of business or were acquired by larger players at low valuations during soft market cycles.
Over the next few years, other competition should come onto the market with comparable products. There is also the possibility that this architecture is not the way of the future. Another faster, better, or cheaper method could be developed. While FIO has a market leading position now, its tough to see them truly building a moat around their business.
Given the uncertain nature of the long-term competitive positioning, customer concentration, high valuation (40x trailing P/E), and a high and growing short interest (59% of float), FIO is a stock to stay away from. The growth may look enticing, but don't let the chart and "home-run" potential fool you. There are other lower-risk, higher-quality companies out there to fill your core portfolio.