Fusion-iO May Have The Technology Of The Future But Expectations Are Incredible

| About: Fusion-io, Inc. (FIO)

Fusion-iO (NYSE:FIO) just came public a few months ago, without much fanfare. The company isn’t a sexy social media darling alas LinkedIn (NYSE:LNKD) or Facebook, but it does help fuel the profitability behind them. When cloud computing as a sector heated up, the stock rallied to over $40. However, after the end of its lock-up period and another secondary offering, shares have fallen back below $30.

While we like the technology behind the company, we think the stock is priced for perfection. There’s a great possibility that tremendous profitability lies ahead, especially with a growth in the amount of data received and used in analytics that will continue for years, if not decades to come. Nevertheless, given the risks associated with this stock, we think its best investors wait for a more attractive entry point.

Company background

Fusion-iO was founded back in 2005, focusing on the new data issues facing enterprises. The company creates both hardware and software data solutions. On the hardware side, the company utilizes non-volatile storage technology, which is also known as NAND flash. For years, flash has only been used in compact storage, alas iPhones, where memory must be accessed quickly and the device cannot be cooled like a traditional PC or mainframe. However, as the technology becomes cheaper, flash, which tends to be more time and energy efficient than traditional dynamic random access memory, becomes a more plausible in mass enterprise usage.

Software-wise, Fusion-iO provides enterprises with its directCache solution. According to the annual report, this technology is designed to intelligently cache frequently used memory so datasets can be accessed quicker and more efficiently.

In its recent acquisition of ioTurbine, the company acquired software that’s able to optimize the performance of virtual machines and servers. With the ever increasing needs of businesses to increase productivity, virtual machines and servers should play a key role in worker productivity gains. With a virtual machine, an employee is able to process workloads on multiple computers with just one desktop. Additionally, these virtual machines work far quicker than regular computers, meaning employees are able to process massive amounts of data in shorter time intervals.

Great technology, but so what?

Though a lot of the technical terms make things difficult to understand, the business model is not. With the likes of Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN), Facebook and Apple (NASDAQ:AAPL) processing ever increasing amounts of data, Fusion-iO wants to help them store and monetize it (Facebook and Apple are two of its largest customers). It’s similar to how we think aerospace suppliers will benefit from the secular strength in the aerospace refresh cycle (read our view on the aerospace cycle here).

In 2009, the company did just $10 million in sales, but that figure increased in fiscal year 2010 to over $36 million, and in fiscal year 2011, to over $197 million. That growth is absolutely staggering, and we think revenues can grow another 65% this year, based on an increased customer base and upgrades from previous customers. It’s nearly impossible to find this kind of growth anywhere, and if the company is successful, it could compound at over 30% annually.

Yet, the profitability is just not there yet. Gross margins have increased by over 200 basis points a year, but SG&A has also ballooned more than three-fold. The company only earned six cents in its most recent fiscal year, but we expect revenue growth to be astounding, implying a great deal of incremental profitability. If such leverage continues, Fusion-iO should be wildly profitable, making its current valuation more reasonable (that is, as reasonable as 112x earnings can be).

Lots of risks from technology and competition

Even though they do have a few patents, Fusion-iO faces substantial risks from competition. On one hand, there are several other companies attempting to ride flash technology to high profits. Some OEM’s like HP buy Fusion-iO’s technology for its own datacenter build-out, but competitors like Intel (NASDAQ:INTC) and EMC (EMC) can create similar hardware and software. Further, these companies already have large installed clientele bases it serves. It also faces competition from smaller players like NetApp (NASDAQ:NTAP), possibly Oracle (NASDAQ:ORCL) and IBM (NYSE:IBM). Many of these are fine companies with much stronger balance sheets.

Additionally, flash is still a premium price-point technology. Seagate Technologies (NASDAQ:STX) and Western Digital (NYSE:WDC) supply companies with traditional DRAM storage which is cheaper, though it requires more cooling and higher energy costs. With some companies still hesitant to spend on IT, some less sophisticated and cash-strapped companies could opt to stick with traditional data centers.

Either way, the importance of data and data processing is not a trend that will stop anytime soon. With the wild amounts of uncertainty, we’d be willing to take a position if shares fell below $14. At its current share price, the risk/reward is only worth it if you think the company can crush the competition. Also remember, the company established provisions to prevent being acquired, so it’s unlikely the company gets gobbled up by any well-capitalized competitor anytime soon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.