Expect STEC to Hit $30 by Next Year

|
 |  Includes: HPQ, HTHIY, IBM, INTC, STEC, WIND
by: John Henderson

Tuesday morning, Oppenheimer semiconductor analyst, Gary Hsueh, raised his price target (PT) on STEC to $30, up from its prior target of $17. After meeting with STEC’s management Monday, Hsueh has become increasingly bullish on the both the short and longer-term outlooks for the company.

With its ZeusIOPS Solid State Drive expanding to full production at IBM, HPQ, and Hitachi (HIT) in Q2 and with an additional 3-4 new customer announcements forthcoming, STEC’s visibility has markedly strengthened in the short term. More importantly, STEC’s management team suggested that ZeusIOPS could reach a revenue run rate of $100 million by the end of 2010, a run rate that is well above current estimates for the year.

Oppenheimer’s new $30 PT is predicated on earnings power for STEC of $2-2.5 a share in 2010. Not willing to go “all-in” on this prediction just yet, Hsueh raised his 2010 numbers to $1.65 a share, well above current 2010 earnings estimates of $1.14 a share. STEC’s estimates for this year and next have been ramped up considerably since reporting blow out numbers and guidance earlier in May. In the past 90 days, 2009 estimates have been ramped up to $.86 a share, up from $.46 a share 60 days ago. Ninety days ago, estimates for 2010 were pegged at $.39 a share. These estimates have now been ramped up to $1.14 a share.

I am expecting additional positive earnings revisions by analysts in the coming months. Just last week, Needham raised their price target to $21 after raising their 2010 earnings estimates to $1.33 a share. Needham believes that gross margins will come in higher than expected in 2010, as ZeusIOPS potentially becomes 70% of STEC’s revenues. Look for other analysts to follow suit in the short term.

With checks at OEM customers showing no new competition in the Solid State Drive market, STEC remains the only game in town. With ZeusIOPS being the only SAS and FC option for Tier 0 Storage, this trend should stay in place well into next year. While Intel (NASDAQ:INTC) poses the most immediate threat, the timeline for its competing drive has repeatedly been pushed back into 2010 and 2011.

Not surprisingly, STEC’s stock keeps powering to all-time highs. Rising earnings estimates have always been the hallmark of the strongest growth stocks and this trend continues to manifest itself with STEC. In the meantime, the shorts are trapped. Short interest is still very high, currently standing at 7.1 Million shares, or 36% of the float.

While some shorts have undoubtedly covered since the April short-interest figures were reported, you have to figure that many of the current shorts are nearing their capitulation point. While insider selling has admittedly picked up somewhat in the past two months, the selling is not pronounced enough for the shorts to hang their hat on in the short-term.

In my article on May 12th, I posited that STEC was on its way to $20 within a few months. Looks like I was wrong on one count, as STEC is poised to hit $20 within one month. With a market cap approaching only $1 Billion, STEC could still very well be an acquisition target.

One has to wonder what premium the company would garner should Intel decide to simply throw in the towel on trying to compete with STEC’s ZeusIOPS. If the proposed buyout of Wind River (WIND) for $885 million is any indication, Intel’s management seems motivated to grow by acquisition, so this is something that is certainly feasible if an attractive premium is offered to STEC’s management.

Where does STEC go from here? With earnings expected to grow $177% this year and new 2010 earnings estimates implying another year of 50-75% earnings growth, look for STEC’s PE to continue to expand. While extended in the short term, trading 58% above its 50-day simple moving average, STEC seems poised for an ultimate move into the $30s and maybe $40 by next year. I am a continued holder in STEC and an add-on buyer on any pullbacks in the coming weeks.

Disclosure: Author is long STEC stock and the August 15 STEC calls.