Adaptec: Value Plus a Possible Catalyst

RAID controller vendor Adaptec (ADPT) is a value play in the technology sector, based on a strong balance sheet, interesting because it has a possible catalyst to ignite growth. Because of the proliferation of digital content, the storage sector offers growth opportunities for companies that can keep up with the technology.

Overview – the company describes itself as follows:

Adaptec provides trusted storage solutions that reliably move, manage, and protect critical data and digital content. Adaptec's software and hardware-based solutions are delivered through leading channel partners and Original Equipment Manufacturers (OEMs) to provide storage connectivity, data protection, and networked storage to enterprises, government organizations, medium and small businesses worldwide. More information is available at www.adaptec.com.

Value Proposition - with the shares closing yesterday at 2.73, the tangible book value per share is 3.24, and cash and marketable securities per share stands at 3.08. Revenue is from legacy products and has declined in recent years, but the company has managed expenses consistent with revenue, avoiding any serious cash-burn. I picked up the idea from an article by David Bui, here on Seeking Alpha. The screen he used was for Ben Graham type value, which frequently produces prospects that stand in need of a catalyst. From there I went through them looking for situations that had something to suggest possible growth, and came up with Adaptec. The name also came up recently, again on Seeking Alpha, in a screen by Cam Hui.

Potential Catalyst – from the latest 10-Q:

Our future revenue growth is largely dependent on the success of our new and future products, obtaining and fulfilling our obligations on OEM design wins, and growing our market share in the channel. In September 2008, we acquired Aristos for a purchase price of $38.9 million, plus an obligation to pay up to $2.4 million contingent upon the employment of certain Aristos employees. We expect that the acquisition of Aristos will allow us to expand into adjacent RAID markets that we believe provide us with growth opportunities, including blade servers, enterprise-class external storage systems and performance desktops, and will provide us with a strong ASIC roadmap. This acquisition should also enable us to pursue new OEM opportunities and expand our future channel product offerings containing unified serial technologies. For example, in October 2008, we announced a design win from IBM for our RAID Storage Processor technology, which was enabled by the Aristos acquisition. However, we cannot predict the extent to which the potential benefits of this acquisition will offset the declining OEM revenue from our serial legacy products and our parallel SCSI products considering our loss in market share and the potential adverse impact on our business of current economic conditions. We expect the revenue levels from our serial legacy products sold to OEM customers to significantly decline over the next two to three quarters. We will continue to seek additional growth opportunities beyond those presented by our existing product lines by entering into strategic alliances, partnerships or other acquisitions in order to scale our business. We will also continue to review and evaluate our existing product portfolio, operating structure and markets to determine the future viability of our existing products and market positions.

The acquired technology opened the door with IBM, and according to the most recent conference call, they are shipping to another large and unidentified OEM. There were only two analysts on the call, which featured a word I haven't seen or heard much of lately - “ramp.” The ramping is anticipated to occur late in the calendar year. From the call:

As mentioned in earlier calls we are very exited that the integration of Aristos will help drive new opportunities for Adaptec. We have already announced that we won an opportunity with IBM. We also have another large well known OEM where we are shipping in low volume.

It is difficult to tell how good the acquired technology is and how successful Adaptec will be in marketing it, or having sold it, in delivering on its promises. But I like those initials, IBM...

Valuation, Risk/Reward – Because so much of the assets are cash and equivalents, these put a floor under the value, so a patient investor runs little risk of serious loss. The shares really ought to be worth 3.08 each, unless the investor is concerned that management is going to pee away the cash. The potential rewards are large, based on the prospect of IBM or another large OEM as a customer, but there is no way to quantify them. So, there is little risk, with large but uncertain rewards. Actually, that combination has its attractions.

Investment Strategy - the company will report its 2009 4^th quarter on May 7^th. A loss of (.03) is expected. My approach here will be to open a starter position now and then listen to the conference call, looking for information on how the company is doing as far as marketing the technology it acquired from Aristos. Listen for the “R word.” Shares have traded from a high of 3.51 to a low of 2.20 during the past 3 months, so by watching and waiting it may be possible to get good pricing.

Disclosure: long ADPT

Comments

[Tom Armistead:]

This situation has deteriorated into a proxy battle between Steel Partners and Incumbent Management. I spent some time reading their various accusations and counter accusations, trying to come up with a nice follow up to this article.

What I finally came up with is neither side is telling the truth, the whole truth, and nothing but the truth. The promising beginnings of new growth are very likely to be trampled in the heat of battle. The stash of cash has become the bone of contention, it's a fight to the finish. Meanwhile if everybody had kept their peace and pulled together they could have salvaged some value.

Shares went down sharply in mid July, when Steel Parners distributed them to investors who requested redemption. Too many of them hit the market and the price plummeted. I bought some and soon after sold out all but 100 shares. It was a nice quick profit, 145% annualized.

But I will sell my last 100 shares tomorrow. It is rare for a small-time retail investor to profit from a hedge funds difficulties. I had that good fortune, why should I go back into these shares and watch in dismay as the two contestants trash the company they are fighting over?

Oct 18 03:52 PM