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I typically pen an article when I feel particularly strongly about a name one way or another. While I am certainly flexible and change my views when the facts change (if you don't, then you are doing yourself a disservice), there are times when I go from having a viewpoint one way to having some very real indecision due largely to a conflict of fundamental views against market dynamics. A name that elicits some indecision for me is Fusion-io (NYSE:FIO).

Some Background

Fusion-io is a controversial name that elicits extreme emotion from both the bulls and the bears. The bears - who believe that Fusion-io is set to hit the single digits - argue that the company's business model of trying to sell performance for a premium is unlikely to be particularly profitable going forward as competition swarms in and eats the company's lunch. The bulls, more optimistic, believe that Fusion-io's focus on software differentiates itself quite nicely from the competition, and that while customer concentration in the likes of Facebook (NASDAQ:FB) and HP (NYSE:HPQ) is inherently risky, the business has been seeking diversification within a wider customer base in the small/medium business arena.

The most recent financial results - in which the company saw a 7% Y/Y decline in its revenue and sharply lower operating margins leading to a net-loss - suggest that the company isn't exactly in the best of shape, and that the optimistic projections from last year of hyper top and bottom line growth simply didn't pan out.

From a fundamental perspective, Fusion-io is deteriorating quickly where it counts, and I believe that the ousting of the former CEO David Flynn was a reflection of the Board of Directors' dissatisfaction with the direction of the business. The question, though, is whether Fusion-io is the next big "winner" and manages to achieve profitable growth in the face of lowered expectations, or if it is a broken business destined for the single digits before a take-out for pennies-on-the-dollar?

Bull Case: A Massive Short Squeeze

Fusion-io shares are very heavily shorted, and as a result, its shares are incredibly volatile. Just how large is the short interest? It's to the tune of 26 million shares and is near a 52-week high:

Surprisingly enough, this market is filled with cheap liquidity, and as a result, short squeezes abound, as we can see with a number of previously beaten down names:

GMCR Chart

GMCR data by YCharts

Now, the problems with Fusion-io are real, but some good news thrown its way could - especially in this environment - lead to some interesting upward momentum. In fact, even at the most recent earnings report which wasn't exactly stellar, the shares rallied hard on the back of a report that simply wasn't "terrible" - surely a result of short covering:

FIO Chart

FIO data by YCharts

But what can go right going forward? Well, essentially, look for the following as upside catalysts:

  • Diversity in Customer Base: this will alleviate one of the major structural fears surrounding the company and will probably get the sell-side back on board the train
  • Confirmation Of Execution Strength: with a new management team in place, the Street may remain cautious until there is evidence that these folks can really drive profitable growth. That means margins stay intact in a backdrop of double digit growth.
  • Hype/Fanfare: These types of highly shorted former momentum stocks typically respond well to hype. While the new CEO confirmed that there are no buyout talks in place, buyout rumors, partnership rumors, and design win traction all typically serve as upside catalysts.

How about on the downside? Well, any sign that margins are compressing rapidly, revenue slowing, failure to diversify the customer base, or design win losses to cheaper, more commodity products from the likes of Intel (NASDAQ:INTC) could further pressure shares as the short thesis plays out.

Conclusion

This is a highly event and news driven name with a gigantic short interest and equally gargantuan volatility. There's a lot of upside potential here, but the downside risk isn't trivial. Be very careful with this stock, especially if you're treating this as a "buy and hold" - this is much more a trader's stock rather than one for the long-term, sleep-soundly-at-night investors.

Good Luck!

Source: Fusion-io: Short Squeeze, Or Short Candidate?