IPO Analysis: Industry Recognition Makes Compellent Technologies Worth The Risk

| About: Compellent Technologies, (CML)

On October 6, Bill Simpson wrote an analysis of Compellent Technologies (NYSE:CML). In its debut October 11, the company placed its price range at $10-$12, but shares ultimately fetched $13.50 and even reached $24.19 on its first day of trading. October 18 the stock closed at $18.61.

The text of Mr. Simpson's original writeup follows:

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Compellent Technologies plans on offering 6.9 million shares at a range of $10-$12. Morgan Stanley is leading the deal, Needham, Piper Jaffray, RBC and Weisel co-managing. Post-ipo, CML will have 30.5 million shares outstanding for a market cap of $336 million on a pricing of $11. IPO proceeds will be used for working capital (to fund losses) and general corporate purposes.

El Dorado and Crescendo Ventures will each own 17% of CML post-ipo. El Dorado and Crescendo each made a mint back in the 1990's, being very early stage tech centric venture funds. It has been quite awhile since one of their companies has gone public I believe.

From the prospectus:

We are a leading provider of enterprise-class network storage solutions that are highly scalable, feature rich and designed to be easy to use and cost effective.

Storage Area Network [SAN] operation; CML has sold their SANs to 600 enterprises worldwide. They call their SAN, 'Storage Center.' CML describes their Storage Center product as follows:

Provides storage virtualization and speeds both common and complex storage tasks by reducing the time and effort required for many complex functions into a few simple point-and-click steps.

Performance: CML is still losing money on the bottom line. Two things however make this an interesting little tech ipo: Recent swift revenue growth and industry acknowledgment of CML's high quality storage solutions. Rarely in the prospectus do you see a company make the sort of claim CML makes. To quote, 'We believe that Storage Center is the most comprehensive enterprise-class network storage solution available today, providing increased functionality and lower total cost of ownership when compared to traditional storage systems.'

Awards: In 2006, InfoWorld selected CML's Storage Center as "Best SAN" and Computer Reseller News selected CML as a top Storage Standout. Gartner, a third-party industry analyst, recently reported Compellent to be the fastest growing disk storage company in the world in 2006.

CML does not sell through a direct sales force, instead relying 100% on channel partners. CML also employs something they call a 'virtual manufacturing strategy' in which their hardware component suppliers ship directly to customers, merging in transit with CML's storage solutions. This helps CML cut down on inventory as supplier components are pretty much drop shipped to CML's customers at the same time as CML's storage products. CML believes relying on channel partners as well as 'virtual manufacturing' lowers their operating cost structure.

Sector - Data storage has been a growing need this entire decade as enterprises are creating vast amounts of data in need of storing. Traditional storage solutions were not developed for the continued need for updated storage. These storage systems were designed to take storage snapshots, storing all data at regular intervals. This has led to massive stored data duplication.

CML's solution: Similar to 'node storage,' CML's solution is based on module 'Dynamic Block' storage architecture. A block is the lowest level of data granularity within any storage system. Dynamic Block Architecture allows CML to record and track specific information about each block of data and provides intelligence on how that block is being used. With the use of modules, CML's customers can easily add storage capacity as they go. CML's block system also allows for automatic movement of blocks of data between tiers of high cost, high performance storage and tiers of lower cost inactive storage. CML believes up to 80% of stored data falls into the 'inactive' area, allowing CML's customers to save money in storing this inactive data in a low cost way.

Virtualization: Dynamic Block Architecture enables end users to create a shared storage pool. Storage Center distributes workloads across the entire pool, automatically improving utilization of storage resources for all applications. CML believes their Storage Center product meshes well with the growing adoption of server virtualization. CML and VMware (NYSE:VMW) have a technology partnership. From CML's website:

Compellent's innovative storage virtualization technology integrates with VMware to create an efficient virtualized data center. Using Compellent and VMware in unison enables customers to improve utilization and lower overall costs with flexible server.

CML currently has eight pending patent applications in the United States, two patent applications filed pursuant to the Patent Cooperation Treaty and four pending foreign patent applications. The bulk of the pending patents relate to their Dynamic Block Architecture.

Historically CML has focused on small and medium sized business. One of their growth goals going forward is to expand their business into larger enterprises. One reason that CML has focused on smaller operations is that the SAN space is dominated by large, well established tech companies. CML's direct competition includes Dell (NASDAQ:DELL), EMC (EMC), Hewlett-Packard (NYSE:HPQ), Hitachi (HIT), IBM (NYSE:IBM) and Network Appliance (NASDAQ:NTAP).

CML has also focused primarily on the US market. 89% of revenues through the first 6 months of 2007 were from enterprises based in the US.

Financials

$2 per share in cash, no debt.

CML began shipping product in February 2004. Since then, revenues have grown briskly. In 2004, CML booked a shade under $4 million in revenues, $10 million in 2005 and $23.3 million in 2006. Through the first 6 months of 2007, CML appears on pace to book $48-$50 million in full year revenues, a 100%+ increase over 2006. Hefty losses have come with the swift revenue growth. CML lost $0.43 in 2006.

2007 - Revenues are on pace to hit $48-$50 million in 2007, a strong 110% improvement over 2006. Gross margins are in the 45%-50% range. CML is such a young company it is not at all surprising that operating expenses here have been hefty in relation to revenues. Operating expense ratio in 2005 was 133%, 76% in 2006 and 68% through the first 6 months of 2007. The good news is that operating expenses are moving in the right direction, growing at a slower pace than revenues. They're still quite robust however, meaning CML is not closing in on break-even just yet. It should be noted that in the 6/07 quarter, CML did have by far both their strongest revenue quarter in operating history and lowest operating expense ratio. Assuming each trend continues in the back half of the year, I'd expect CML to hit 62% operating expense ratio for the full year 2007. Losses for 2007 on $49-$50 million in revenues should be approximately $0.20 - $0.25.

2008 - With a company this young growing revenues this swiftly, we'll need to see the last two quarters of 2007 before predicting 2007. Assuming strong growth continues, CML should be shifting towards operational break-even sometime in the back half of 2008.

Positives here are pretty clear: Swift 'hockey stick' type revenue growth from recent start up stage, industry awards, and a technology partnership with hyperbolic tech growth company VMware. Really that is enough to recommend CML in range. There are numerous risks here going forward that need to be mentioned. CML is coming public a bit too prematurely in their revenue and profit curve. This greatly heightens the risks going forward. As CML relies on one product (Storage Center) for the bulk of their revenues, any end market hiccup in quarterly demand/revenues would lead to a rather significant drop in share price. This is a very difficult and competitive sector filled with large players more than willing to cut margins to increase their market share and drive smaller companies such as CML out of the game.

One need only to look at recent storage ipo Isilon Systems (ISLN) for an example of what can go wrong with these types of young fast growing ipos; it is the pace of that growth stalls. In addition CML has never booked a quarterly profit and losses should continue annually for full year 2008. All this means one does not pay up heavily for this ipo. However, with an initial market cap in range of $350m or so, CML is worth the risk here. Personally I'd be far more comfortable if CML had one more year of revenue growth while shifting closer to break-even before accessing the public markets.

Recommend in range due to swift growth from recent start-up stage, industry awards/recognition and the technology partnership with VMware.