OCZ Technology Group Seems Extremely Undervalued

May.22.12 | About: OCZ Technology (OCZ)

It's not often that one runs into a stock that is as incredibly and obviously undervalued as OCZ Technology Group (NASDAQ:OCZ). OCZ is a prominent producer of solid state drives for the consumer and enterprise markets. Recently, the stock price has plummeted from north of $9 in February to just above $5 as of the close on 5/17/2012, and I believe that this loss in value is completely and utterly unjustified, and as such, this represents a tremendous buying opportunity.

Why? Well, first and foremost, OCZ has exhibited extremely strong growth. FY2011 revenues were $190.1M, $133.2M of this was SSD revenue. OCZ then grew revenues for FY2012 to $365.8M, of which $338.9M was SSD revenue. The analysts were expecting $512.98M, but OCZ guided $630M-$700M for FY2013 (and management makes it clear that this is a conservative estimate that excludes a lot of potential sources of revenue such as PCI-E drives). So even at its most conservative, this would represent 72.2% revenue growth year-over-year. I would say that it's a fairly safe bet that OCZ at the very least hits the midpoint of this guidance, and there's a pretty decent chance of even exceeding the high end of the guidance. The point, however, is clear -- OCZ is growing its business dramatically.

Next, the question of profitability comes up. OCZ posted a surprise loss in the most recent quarter, so concerns about OCZ's long term profitability are at the core of the bear thesis for this company. However, it's absolutely important to understand that OCZ is a growth stock. That means the focus right now is on expanding the business -- that means hefty investments in R&D, capital expenditure, marketing and sales. So right now, looking at the bottom line for OCZ is pointless -- the key metric to examine with respect to profitability is gross margin! And OCZ has not failed here; gross margins have been improving, hitting a record 25% in Q4, up from 16.6% a year ago, and up sequentially from Q3's 22.5%. In the latest conference call, OCZ has guided that they will exit the year with 30+% gross margins.

The last potential issue is that of differentiation. OCZ had traditionally licensed controller technology from SandForce and Indilinx. However, there will need to be consolidation in the SSD industry, so to avoid becoming just another low margin SSD manufacturer that hands over licensing fees, OCZ acquired Indilinx. This leads to a much more vertically integrated, differentiated OCZ. There was some controversy over the use of Marvell hardware in the latest OCZ Vertex 4 lineup, but with SSD controllers, the key differentiation is the *firmware*, rather than the *hardware*. Different firmwares are what control an SSD's strengths and weaknesses, how well they handle certain types of workloads, how stable the drive is, and so on. OCZ's ownership of Indilinx means that they can develop controller platforms. This will lead to more competitive pricing and higher margins, which translates into a stronger bottom line. Also -- and this is not factored into their guidance -- OCZ can license controllers to other SSD vendors in a similar fashion to SandForce and make a solid, high-margin licensing premium from it.

So it's just baffling that OCZ is trading at a $340M market cap, with a strong presence in the consumer market (both OEMs and the channel), an increasing presence in the datacenter/server storage market, unique controller platforms, and an aggressive management team that clearly believes in investing in its own future.

Disclosure: I am long OCZ. I may add to my position within the next 72 hours.