Emulex Offers Good Risk/Reward

Emulex (ELX) designs develops and sells fiber channel host adapters and embedded storage switches for storage area networks [SAN] and network attached storage [NAS]. They use contract manufacturers for actual fabrication of their products.

ELX is totally debt-free and as of September 2007 they had around $275 MM or about $3.30 /share in treasury cash. Guru George Soros added greatly to his position in the final quarter of 2007. At year-end he owned 719,715 shares of Emulex.

Earnings from continuing operations were $0.77 in FY 2006, $0.90 in FY 2007 and are projected to be higher in the current FY ending June 30, 2008. Zacks looks for $1.00 while Yahoo Finance consensus estimates are centered on $1.22. For FY 2009 they are now at $1.15 and $1.35 respectively.

Large holders at Year-end 2007 were:

Wellington Management....9.02%
Primecap Management......7.38%
Invesco Ltd.................... 5.85%
AXA...............................4.34%
Barclays Global Inv............3.99%
Schroder Inv. Mgt............3.77%
State Street....................3.29%
Vanguard Group...............3.11%

Emulex has typically commanded a P/E above 20x. In fact, there has only been only year in the past 15 that its average annual P/E was lower. Value Line is using a twenty multiple for their 3 - 5 year projections.

Not only is ELX's P/E lower than normal but it also is cheap based on its price/cash flow and price/book value compared with the best historical previous buying opportunities.

At previous low points [when it looked similarly valued to today] here is what the share price did:

[All prices are split adjusted]

This is a great trading vehicle as it has a high beta and moves from undervalued to fairly valued or over-valued without having to wait years for the moves.

As a debt free and profitable company with a big cash hoard its survivability while you wait is not in question. The many large value-oriented holders seem to agree that Emulex offers a good risk/reward.

Even 18 times the calendar year lower-end estimate of $1.12 for 2008 would bring ELX shares back to $20.16 or up 33.3% from Friday's quote.

Is that target price attainable? History says yes. Emulex shares have hit at least $22 at their peaks in each year from 1999 right through 2007. ELX shares were not lower than today's price in 2005 or 2007 and their exact low in 2006 was $14.10 - not too far below the current price.

With their huge cash holdings and no debt Emulex shares look like a good risk/reward proposition to me.

Disclosure: Author is short puts on ELX.