OCZ Technology Update: Boosting Estimates

Feb.10.12 | About: OCZ Technology (OCZ)

OCZ Technology (NASDAQ:OCZ) CEO Ryan Petersen should be feeling pretty good right now. Last Wednesday OCZ launched a 10 million share offering. By the time they priced the upsized 12 million share offering (a day early), the stock had risen almost 12%. The burning question, however, is "Why?" OCZ appears to be well capitalized and indeed recently finalized a new credit facility. After a year of choppy performance, the stock had only recently surpassed the $8.50 level where a previous offering had priced. So why raise capital now? I suspect this offering speaks volumes about the trajectory of OCZ's business, and I think it's very bullish for investors. I have adjusted my model to reflect the recent offering, and I am raising my estimates. My 12-month target is raised from $20 to $28, which equates to 2.7X EV/Calendar 2012 Revenues, 35X C2012EPS, and 20X C2013 EPS. I continue to believe OCZ is the most attractive way to invest in the rapidly evolving data storage sector.

New fiscal and calendar estimates are as follows:

Old

New

Old

New

Rev

Rev

EPS

EPS

($mil)

($mil)

$ $

F2012e (Feb)

372.0

372.0

0.16

0.16

F2013e (Feb)

520.8

721.2

0.69

1.04

F2014e (Feb)

592.3

926.5

0.83

1.44

C2011A

320.1

320.1

0.03

0.03

C2012e

496.0

617.1

0.59

0.80

C2013e

580.4

906.9

0.81

1.38

Click to enlarge

OCZ designs, manufactures and sells solid state drives (SSDs) for consumer and enterprise data storage markets. In my opinion, the SSD market reached an important inflection point in its growth trajectory in 2011 largely because of the dramatic performance improvements and cost savings achieved by OCZ's MLC-NAND based drives, and SSDs are expected to rapidly take share from traditional hard drives for the foreseeable future. Indeed the value proposition for the enterprise market has improved, as SSD cost per IOP has recently dropped below that of HDDs. Readers may recall that I have enthusiastically written on OCZ in the past; my previous articles may be accessed here and here.

Although OCZ stock has faced the headwinds of investor skepticism, it is important to recognize that management's execution to date has been excellent. In the past year they have launched a parade of highly rated new products for HPC, server, enterprise, and consumer markets. They have doubled capacity. In a drive toward vertical integration, they have made three strategic acquisitions: Indilinx, which provides OCZ its own proprietary controllers; the storage team from PLX who had worked on OCZ next generation controllers; and SANRAD, which brings proprietary flash caching and virtualization software and hardware. In addition, they have developed a flash processing capability which can add as much as 3-400 basis points to the gross margin. They raised guidance twice during the last quarter, then delivered 94% revenue growth, 130% SSD revenue growth, and a $0.06 non-GAAP profit for the fiscal third quarter. They raised fiscal year revenue guidance (for the fourth time) to $360-375 million. In a nutshell, these guys have crushed it…knocked the ball out of the park.

Against that backdrop, the most important driver for my raised expectations is the new Z-Drive R4 PCIe product. Launched in August 2011, the Z-Drive R4 addresses the estimated $23 billion SAN replacement market which has previously been addressed by only one competitor, Fusion-io (NYSE:FIO). As noted in my previous article, third-party reviewers have found the Z-Drive R4 compared favorably to the IODrive Duo in both performance and price. But importantly, this is a large, unpenetrated market which will easily support more than two competitors. In fact, both OCZ and FIO have indicated that their main competition is the HDD; they seldom see each other in competition. OCZ has over 500 Z-Drive R4 client trials ongoing, and they have received the first wins from beta tests over the past month. I expect more and larger wins over the next few months. And importantly, Z-Drive R4 gross margins are over 50%...more than twice the corporate average.

These ongoing Z-Drive R4 trials are the reason I was thrilled to see OCZ come to the market with a stock offering. Since OCZ finalized its credit facility in the F3Q, CEO Petersen has consistently said that existing working capital would support revenues up to around $720 million. The consensus revenue forecast for the coming fiscal year is just under $500 million. But Petersen gets to see his order book; Wall Street does not. This offering suggests that Petersen wants to enter the new fiscal year with sufficient working capital to support revenues at least 45% higher than Wall Street is forecasting! I can take a hint. Realistically, one or two Tier-1 customer wins could account for the entire increase in my F2013 revenue forecast and would provide an enormous endorsement for the company. Moreover, the higher gross margin on these sales could easily drive overall gross margins to the middle of management's long-term 30-40% target.

I have noted before that the current valuation awarded OCZ is out of whack with the fundamental performance of the company. But over time, markets tend to give credit where it's due. Although FIO shares have declined, they still trade at 5.5-6X C2012 revenues. Even if I assume OCZ's traditional SSD business is worth only 1.3X C2012 revenues, the fast-growing PCIe business should be worth 6X C2012 revenues. This yields a blended 2.7X EV/C2012 revs which equates to a $28 target over the next 12-months.

Disclosure: I am long OCZ and may add to the position over the next 72 hours.