Voltaire: Great Potential, Expensive Offering

| About: Voltaire Ltd. (VOLT)

Voltaire Ltd. (VOLT) and its selling shareholders are offering 7,693,000 share in the price range of $12.00 and $14.00 per share. The company was incorporated under the laws of the State of Israel in April 1997.

The company is a leading provider of server and storage switching and software solutions based on the InfiniBand architecture, as well as grid management software that enable high-performance grid computing within the data center. Its solutions allow one or more discrete computing clusters to be linked together as a single unified computing resource, or fabric.

Simply said, the company provides solutions for cluster to cluster networking with high-performance interconnects normally known as grid computing or grid formation (a cluster normally consist of a high performance server and auxiliary storage units).

The company intends to use the net proceeds from this offering for research and development activities,to expand its business development and marketing activities, for general corporate purposes, working capital, and to repay a loan with an outstanding principal amount of $5.0 million. It may also use a portion of the net proceeds to acquire or invest in complementary companies, products or technologies.

Financials ($ in million)

In fiscal ended December 31, 2005 the company earned revenue of $15.36 million, Gross profit of $4.5 million and operating loss of $10 million. In fiscal ended December 31, 2006 the company earned revenue of $30.5 million, Gross profit of $11 million and operating loss of $8.3 million.In Quarter ended March 31, 2006 the company earned revenue of $4.4 million, gross profit of $1.5 million and operating loss of $2.8 million.

In Quarter ended March 31, 2007 the company earned revenue of $8.6 million, gross profit of $3.2 million and operating loss of $2.6 million.

Business/Company Outlook

Its Data warehouse/Data center business is growing at rapid pace and is expected to keep or rather extend its pace in future; this growth will in turn will create more and more demand for switching, networking (grid computing) products and solutions. As per estimates overall grid computing market will grow from $3.9 billion in 2006 to $6.9 billion by 2010.

Voltaire revenues have shown considerable growth in the last few years from $0.5 million in FY 2004 to $3 million in FY 2006. The company shows this growth mainly due to the commercialization of a few of its developed products in these years. Despite this growth company is still making loss at net as well as operating level mainly due to high research and development expenses, high sales and marketing expenses, but the benefit of these expenses is clearly reflected in its ever rising revenues with the introduction of new products. High spending on sales and marketing help the company to not only grew its revenue but also enable it to build up a highly impressive OEM relationships will biggies like HP (NYSE:HPQ), IBM (NYSE:IBM), Sun Microsystems (NASDAQ:SUNW), Silicon Graphics (SGIC) and NEC Corporation (NEC) that account for more then 60% of company's revenue. These relationships themselves reflect the rising acceptance of products developed by the company in the market.

Voltaire is a R&D based company which develops and sells products/solutions for high end cluster to cluster linkage or networking (grid computing) based on InfiniBand architecture. The company does most of its R&D in-house, although it subcontracts the manufacturing, assembling and testing of its products to other contract manufacturers.

The company develops its products based on InfiniBand architecture but simultaneously its products are flexible enough to work across multiple architectures (like Ethernet, Fibre Channel), which allow customers to install its products without replacing their existing infrastructure, further its relationship with OEM suppliers not only allow it to introduce its products to potential customers but also allow its customers to compare its products with other products based on competing architectures, which in turn allow company to show superiority of its products over other products. Since its products normally cater to the high end grid computing market like data centers with large installation, normally it earns its revenue from few big size orders which make it open to quarter to quarter and even year to year revenue fluctuations as wining or losing one big deal/client will make revenues rise or decline steeply.

Company's principal competitors are Cisco Systems, Inc. (NASDAQ:CSCO) and QLogic Corporation (NASDAQ:QLGC).

Currently the company is working with operating margins of nearly -30% and the only way to convert these negative margins to positive is by growth in revenue because there is no possibility of reduction in R&D expenditure, sales and marketing expenditure in absolute numbers, these expenditures can only be reduced in percentage terms as compared to revenue.

Valuation/Offer value ($ in thousand)

(The company may not be able to perform this well; chances of company performing this well is four out of five)

Assuming that the company shows (if nothing negative happens to company and it performs just ok, although due to growth potential of its business and strong R&D, the company has the potential to grow faster and can perform better than these assumptions.)

(Assumptions include the effect of debt repayment from funds raised through this offering.)

1. 65% percent rise in revenue year on year in FY 2007 and FY 2008 from $30427 in FY 2006 to $50205 in FY 2007 and to further $82838 in FY 2008.

Historically the company's revenues are growing at nearly 100% per year but on a lower base; now on a bigger base we assume company's revenue growth rate can decline, although there are still very good chances that company can maintain its historically growth rate.

2. Gross margins rises by 5% each year from 37% in FY 2006 to 42% in FY 2007 and further to 47% in 2008.

Gross margins can rise on account of two things, higher sales of high margin products and economy of scale due to higher sales.

3. Operating profit margins improves from -27% in FY 2006 to -7% in FY 2007 and further to 9% in FY 2008.

Operating margins can improve due to higher gross margins. Reduction of R&D expenditure, sales and marketing expenditure in % term as compare to revenue.

This leaves the company with operating (loss)/profit of ($3515) and $7456 in FY 2007 and FY 2008 respectively and after detecting interest cost of nearly $99 and $99 and income tax at 29%** This leaves the company with net loss/ profit of ($3613) and $5223, that is EPS of $(0.18) and $ 0.26 for FY 07 and FY 08 respectively. This means if nothing negative happens with company and it perform just ok, at an offer price of $13 company's shares are available at two year forward PE of nearly 51.

** Israeli companies are generally subject to corporate tax at the rate of 29% of their taxable income in 2007. The rate is scheduled to decline to 27% in 2008, 26% in 2009 and 25% in 2010 and thereafter.

We rate this IPO 2 on scale of "1 to 5" (5 for best)


· Company's loss making history.

· Offer price extremely high.

· Any introduction of new technology/product better than company's can hit company hard.

· Low cash flow.

· Revenues can fluctuate quarter on quarter and even year on year due to nature of industry.


· High growth rate of company as well as industry.

· Any acquisition will accelerate this growth rate further.

· Healthy balance sheet. (after this offering).

· Possible breakeven in near future.

· Strong R&D.

· OEM relationship with big companies.

· Funds raised from this offering will give company much needed financial strength to develop and market its products worldwide and to compete with other big players more effectively.

· Currently company is paying 3.5% royalty on its revenue to repay the grants it used for its R&D needs till FY2005. As of March 31, 2007, the royalty amount payable was approximately $4.4 million. Since FY 2006 company is not utilizing any R&D grants, So ones the outstanding amount of $4.4 million get repaid by company in about two years its operating margins will further improve by 3.5%.

Disclosure: This article reflects personal view of the author about the company and one must read offer prospectus and consult its financial adviser before making any investment decision