QLogic Corp. (QLGC) has an enviable business: the profit margins (gross margin 66% and net margin 23% in 2011) are off the charts, even among tech companies. However, the share price has languished for the past decade. It went nowhere. In fact, the stock price was lower than what it was 10 years ago (there is no dividend so the shareholders were losing out if they invested 10 years ago). The problem, I think, is that the managing of cash and financial strategies remain as challenges for the company.
The company generated a lot of cash in its history, but instead of using it to invest in accretive assets or other lines of R&D, it "returned" cash of over $1.6 billion to the shareholders in the form of share buybacks since 2003. I am definitely not a fan of share repurchase and am skeptical of the concept of "return of cash" using a repurchase program. QLGC is a perfect example of this.
In the high tech industry, in which QLGC is operating, the need to reinvent itself is more pressing than in other industries. The cash that was returned to the investors could have been put to more productive use to expand its product line, to acquire other cross selling technologies, or to enhance its position further in its own markets. The returning of cash actually greatly hindered its own growth. Technology companies could be penalized for not growing enough.
The industry has offered ample growth potential for the company. The red-hot concept of cloud computing, big data, and networks are all of the companies' playground. Typically, when a company is fortunate enough to have a cash cow business like QLGC has, the cash is used to nurture the next big cash cow. What we see is that the cash was used to retire shares, which by itself does not generate any return. The cash is gone and dead. For repurchase to truly be beneficial to the remaining shareholders they must choose to repurchase the shares when share prices are significantly lower than its intrinsic value.
Invariably companies always choose to pay much higher prices in repurchases. In fact, the share repurchase programs have been greatly abused by companies at large these days. Many companies could claim to "return cash" to shareholders but fail to answer the question of at what price; therefore, what good does is that for the remaining shareholders? Or does the repurchase price make sense? In some other occasions, share repurchase was used conveniently to buy back managements' stock rewards.
Another thing I noticed is the sale and marketing expense. QLGC has very mature and established relations with its customers. Its customers are concentrated (the top 3 customers accounted for 55% of revenue in 2011). The revenue was not growing at a double-digit rate. But the sales and marketing expenses were over $80 mil in 2011, or over 13.5% of sales. It is perplexing to say the least. I don't know who was selling their products, but the commission suggests it was a rock star.
Is this stock undervalued? The stock market can be wrong, but it's hard for it to be wrong for 10 years consistently. QLGC's stock price has told a story of a great profitable company stuck in a rut. Are shareholders happy? The share price answers this question more eloquently than I can.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. DeltaRock Capital LP, under the management of the author, has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.