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In my recent earnings preview piece on Fusion-io (FIO), "Fusion-io's Upcoming Earnings: Will Lightning Strike Twice?", I concluded the following:

Fusion-io is expensive. Extremely expensive. With a market capitalization of $2.62B and trailing twelve month revenues of $359M, it is already priced to perfection. The company expects a revenue increase of 40-50% for FY2013 or roughly $502M - $538M , which is very strong growth. If the company can keep up this growth trajectory and consistently execute, then it will not be in any danger of losing its lofty valuation. However, if it shows any signs of weakness in either the current quarter or in its forecast (ala Mellanox (MLNX)), then shares of the company will likely very quickly fill the upside gap from August 10th.

Given that the stock has gone from a hair over $29/share to just over $24/share post-earnings, it is now time for potential investors (and current ones) to determine the following:

  • Why did the stock drop?
  • What is the risk/reward at these levels?

In this article, I intend to give my view of the answers to these questions as a potential investor in the company.

Why Did The Stock Drop?

The most prominent question on the minds of both potential buyers as well as holders of shares is, "why did the stock drop so dramatically?"

It all comes down to the expectations. Fusion-io actually came in slightly ahead on the revenue side at $118.1M, beating consensus of $111M. However, the guide for the next quarter was "essentially flat", below the consensus guide of $125M.

An interesting detail behind this "switch-a-roo" was noted on the conference call. Essentially, a $10M order was pulled in from the next quarter into the current quarter. So if we "move back" that $10M into the next quarter, we really had $108M in the current quarter and $128M in the next quarter. This would imply a $3M miss in the reported quarter and a $3M beat in the next - averaging out to be essentially "in-line" with estimates.

The problem with "in-line" with estimates - no matter how much growth these estimate bake in - is that Fusion-io is typically well known for guiding conservatively and then revising guidance upwards. It seems that the "analyst expectations" were set in the hopes that they would be beaten. They weren't and so this "in line" quarter + guide really turned out to be "below expectations"

What Is The Risk/Reward?

At the last closing price of $24.10, the stock is near the low end of its 52-week range of $17.45 - $41.74. However, it is important to realize that in the interval between the 52-week low and 52-week high, the company has issued a secondary, diluting the float. Further, while the growth story seems to remain intact, there is the looming threat of competition in certain areas of the technology from companies such as LSI (LSI).

That being said, the stock recently traded at the $30 level, and any good news, design wins, expansion of the client base from such high concentration in Apple(AAPL), Facebook (FB), and HP (HPQ) and future earnings beats could be significant upside drivers.

The stock is heavily shorted, which adds significantly to the volatility of the price action. When the news is good, then there tends to be an overreaction to the upside, but if the news is not good or even just average, then there is a disproportionate reaction to the downside.

At the $24 level, I believe there may be little more room to fall if the general market declines, although it seems to have found some nice support at $24. While more aggressive investors may want to begin a positions at these levels, more conservative ones may want to begin a position at the $21 level, which is where the major upside gap from the last earnings report happened. When/if this gap fills, it will be much safer to start a long position.

A Few Notes On Risk Management

If you're a trader, then this does not apply to you, but if you are looking to invest in this company (or any other non-dividend paying stock), then scale in stages. Buy 1/4th of the desired position at first, and in the case that the stock continues to fall, add these 1/4th chunks. That way, you can attempt to secure a better cost basis.

Further, with a stock like this that is volatile, highly shorted, and reasonably speculative in nature, it is imperative that any investment here be something you can afford to lose. Too many times I have seen people go "all in" on a very risky stock only to find a significant portion of their wealth destroyed.

Conclusion

After this drop, more aggressive investors may want to consider starting a position. More conservative and risk averse ones may want to wait to see if the gap from the $21 level is filled before starting to buy.

In any case, the company is profitable and has strong proprietary technology - it is not running a commodity flash business, so the growth prospects are quite healthy and attractive. I like the company, I like the management, and I'm definitely looking for a nice entry point for a long term position.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FIO over the next 72 hours.

Source: Fusion-io: Is It Time To Go Long This High Growth Enterprise Storage Play?