Now that the company has a rock solid balance sheet, excellent execution and very low enterprise value, is this Silicon Graphics International's (SGI) time to shine?
We like SGI because it fits our model. Our goal is to select, purchase and monitor companies in an effort to gain outstanding performing investments while minimizing risk for our clients. We will cover part of our review and selection process as well as explain why SGI has currently become one of our selections.
First, know the following: On April 1, 2009, SGI filed for Chapter 11 bankruptcy protection, again, and announced that it had sold all of its assets to Rackable Systems for $25 million. The sale increased to $42.5 million and was finalized on May 11, 2009. At the same time, Rackable changed its name to Silicon Graphics International as its global name and brand.
Step 1 - We first search for companies with pristine balance sheets.
After the purchase and name change, the new SGI has roughly $154.8 million in cash, or $5.10 per share, and no long term debt after completion of the December quarter. SGI has a very strong balance sheet.
Step 2 - We like extremely low enterprise values.
When you subtract out the cash from the enterprise while remembering that SGI has no debt, its enterprise value (the value of the ongoing operations of the company) is actually extremely small for a company that just completed a single quarter with over $150 million in pro forma revenues.
If you subtract out all the cash from the remaining value of the company, the ongoing business is only worth about $218 million. This makes the business value smaller than the just completed quarterly revenues, which is remarkably low for a leading computer company with a run rate well above $500 million in revenues. SGI is achieving size, scale and many competitive advantages while only having a handful of competitors. Additionally, having an impressive ability to leverage new business revenues in both storage and services while attaching more value onto to their established and strong position in server sales, they have a nice business model.
Step 3 - Is the operation or enterprise driving value to their shareholders?
SGI receives another "yes." The company had an outstanding quarter with a 18 cent pro forma profit, which is well above the average estimate of a loss of 8 cents, while solidly expanding and, better yet, forecasting a continuously expanding margin for the year. Possibly even more impressive is that SGI grew its cash this quarter by over $31 million, which was a whopping 25% greater than last quarter.
An impressive metric measurement of its execution was that the new SGI's international revenues are up about 12 times in one year to 29% of total revenues. With this knowledge and the history of SGI, the new SGI has strong execution and growth.
Now knowing the excellent performance on the international markets, SGI's current forecast of doubling storage business in three years to 30% of total revenues seems very palatable. In most companies this would be seen as a Hercules-type of event, especially in this economy; For SGI, though, it's just part of normal execution.
Step 4 - Is this a good business?
We believe this is a very good business with both new and established clients adopting a slow but steady migration to the cloud-computing concept, while at the same time the cost of high performance computers is rapidly falling. This allows for a high growth, low cost, open-architecture computer company to be in a very enviable position. SGI is a leading developer of enterprise-class, high performance systems that feature individual configurations that could include thousands of Intel x64 based microprocessors with Linux operating systems. The standard combination of Intel x64 architecture and Linux operating environment combined with their own differentiated Linux extensions gives companies that purchase SGI advantages in improved performance, simplified system management, reduced operating cost and a much more robust development environment.
When Rackable purchased the assets of SGI, they also attained over 700 patents in the high performance computers as well as many large customers.
Step 5 - Is the train wreck and the fog clearing?
When finding companies around cash value, often a "Train Wreck" is needed to drive value close to cash. With SGI, it was assumed it was a never ending train wreck, but some of the major concerns include:
- Questionable success of two uniquely different companies merging, knowing the more established one never gained success in years.
- SGI's history of having great technology, but poor sales or execution.
- Questioning if Rackable would be able to provide it's high growth, while accruing a much larger company.
- In 2006 and 2009, SGI went into bankruptcy, giving SGI, without proper due diligence, the image of a perennial looser.
I believe all of these factors and more have been priced into this company's current price. First of all, SGI will survive if it's profitable with a high pile of cash and no debt.
Rackable Systems (the purchasing company) was a completely different story and went public in June 2005. According to Gartner's October 2007 server report, Rackable Systems was the fourth largest x86 server provider in North America. Also, in 2007, it was rated the fastest growing server provider in North America, outgrowing all the majors like Sun Microsystems, Dell (DELL), Hewlett Packard (HPQ) and IBM (IBM) on a unit percentage basis. With Rackable Systems (the little guy) purchasing SGI (a technology leader), this could come out far better than it has been priced for.
The new SGI has now demonstrated over the last two quarters that the execution of Rackable Systems combined with the technological muscle of SGI to date has been a wonderful marriage, with some of the best execution in the business whether we perceive them having a low enterprise value or not.
We believe SGI has a value, execution and balance sheet like those past companies that fit our model, so we're hopeful that SGI will have a similar outcome knowing that other companies that fit this model have preformed well. Knowing that SGI has completed two excellent quarters in creating value for their shareholders and now that the new company has completed over 6 months of history, we ran the following two traditional valuations of SGI to put a value on the new company:
1. Price Earning or PE Based:
Durig Capital is currently forecasting that SGI will produce an annual run rate of 72 cents per year pro forma. With SGI's margins, revenues and profits all expanding, SGI should at least achieve some industry parity in value. When the Diversified Computer Industry's average PE of $17.55 is applied to SGI, this would give ongoing business a value of $12.63. Then, when you add the cash of $5.10 per share, we believe that SGI could achieve a stock market value of $17.73.
2. Revenue Based:
If you value SGI at 2.48 times sales (again, the computer diversified sales average) using SGI's guidance of $500 million in sales for their current year plus the $5.10 in cash currently on the books, it adds up to a $46.50 stock market value.
Either way, today you could easily demonstrate based even on the lowest result (the PE based valuation) that with SGI's current model, low valuation and especially with their short term superb execution, SGI could and should, in our opinion, be valued significantly higher.
Disclosure: It appears the top management is fairly compensated. Durig Capital owns SGI in it's client, related and own accounts. We started buying around $8.89 per share.