Gigamon's Weak Guidance: An Opportunity To Scoop Up Cheap Shares

Jul. 9.14 | About: Gigamon, Inc. (GIMO)

Summary

Gigamon announced weak preliminary Q2 results with a 17% drop in forecasted revenues. This caused a 30% drop in price.

Management has over-promised and under-delivered, causing investors to lose confidence in the company and its leadership. This could make for a cheap M&A target for competitors.

Going forward, top line will grow at a slower pace than in the past. At a P/S ratio of 2.7x, market is pricing as if all growth is gone.

Gigamon (NYSE:GIMO), a network traffic management software provider, announced weak preliminary results for its 2014 second quarter. Gigamon projected revenue for the quarter at about $35 million, below the company's previous guidance of $38 to $42 million. This 17% drop in forecasted revenue has caused the stock to drop 30%. Margins and operating expenses are expected to be consistent with guidance.

Projecting Q2 Financials

During the first quarter earnings call, Gigamon management projected Q2 gross margins of 78% to 79%, operating expenses of $28.5 million to $29.5 million, and non-GAAP tax rate of approximately 35% and based on an estimated average diluted weighted shares outstanding of approximately 34.5 million. Using these projections, the Q2 I/S will look something like this:

Gigamon's top line growth will have slowed down from the usual 25% to fewer than 10%. The question will be whether this can be listed as a "bad quarter" or a new norm. Management claimed that the challenge with growth was due to closing deals during later stages of the quarter, as approval cycles have been longer. This would indicate that growth should pick up in the future and that this recent hindrance is only temporary.

The Fundamental Picture

With around $143M (or $4.15/share) in its cash balance, Gigamon offers shareholders a safety net as 1/3rd of the company value is held in cash. Trading at a market cap of $400M and TTM revenues of ~$149M, Gigamon's price to sales multiple has fallen to 2.7x. This multiple is in the same range as large companies such as Cisco (NASDAQ:CSCO), Juniper (NYSE:JNPR) and Brocade (NASDAQ:BRCD), all of which have seen growth desiccate.

Going forward, I expect the company to grow, albeit not at 25%-plus. However, to expect growth of 15% would be a reasonable assumption to make. At current levels, Gigamon looks to be cheap if it can achieve such growth rates.

Mis-management Fixed Through Acquisition

Gigamon has lost roughly $400M in market cap (or 50% of its value) due to the last two disappointing earnings releases. I blame management for such mistakes because they have over-promised and under-delivered. Investors have lost confidence in a management team that cannot manage to forecast its own operations three months into the future.

By trading at these depressed levels, Gigamon is a likely strategic M&A candidate. Its technology, residual growth and reasonable valuation are enough selling points to catch the attention of potential suitors such as Cisco or Juniper. Though shareholders may not want to be acquired at these levels, having the experienced leadership of an established giant will prove to be beneficial for Gigamon moving forward.

Conclusion

Investors of Gigamon should ask themselves whether a 17% drop in quarterly revenues justifies a 30% drop in the stock price. To me this drop is exaggerated, making Gigamon an attractive opportunity to grab shares at a discount. The company will continue to grow, though at a slower pace than before. Yet, it's being priced as if growth is all but gone.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.