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I have over 20 years of experience as a technologist, institutional investor in public market equities and private companies. ================ I have over 20 years of experience as a technologist, institutional investor in public market equities and private companies.
  • Revisiting STEC investment thesis
    I got this wrong. However, now that the emotions are out and the stock has settled into a new trading range, I thought I will take the time to analyze what happened and figure out where to go from here.
     
    What happened at the Q3 Earnings announcement?
     
    While STEC reported numbers in-line with consensus expectations, the only positive standout was Mach8 revenues which grew over 50% sequentially. The EMC revenue being sell-in (as opposed to sell-through) and contractual was not meaningful to analyze, but non-EMC Zeus IOPS was a disaster, which meant IBM, SUN, etc all underperformed. A miss on total revenues was averted through an un-anticipated jump in the “Other” revenue line with generous help as I understand from flushing the Dell product.
    The Company also guided down Q4 revenues to a range of $101 to $103 Million. While this was not bad enough, STEC then announced that the sell-through of the EMC contract revenues of $120 Million which was to be exhausted by end of Q4 is going slower than expected and that EMC might hold inventory into 2010. By not being able to provide any magnitude of the inventory level or actual sell-through progress, they created complete uncertainty on the run-rate revenues, growth rate and margins.
     
    The stock market reaction was decidedly vicious, but more so due to two major reasons:
    1. Uncertainty over underlying demand and growth rate: While there was some chatter that this was all due to competitive pressures, even a cursory analysis shows that it was not the case. The slowdown was all in the Company’s Zeus IOPS product (goes primarily into storage arrays) which currently has minimal competition. On the other hand, the Mach8 product that goes primarily into servers where there is lot of competition from FusionIO, Intel, etc actually grew over 50% sequentially, albeit from a small base. A sequential drop off in SUN revenues was anticipated, but is a one-off issue. So what happened with EMC, IBM, HP, HDS, etc? Was STEC and enterprise SSD’s the enterprise computing equivalent of Crocs (CROX) – a flash in the pan with no secular growth drivers? The answer is an emphatic NO. The need for Tier-0, a persistent storage tier that exists between fast, but expensive and volatile (non-persistent) DRAM cache and inexpensive and persistent, but very slow HDD is very much needed in the enterprise. Once NAND prices fell below DRAM few years back and the spread started widening, the economics was created and the nascent technology got converted into a robust, working product with compelling benefits for the end user and good economics for the vendors. The enterprise OEMs who adopted STEC and the startups and large companies that are chasing STEC are not all wrong. All what happened was the technology and expectations just got ahead of the supporting infrastructure catching up. Here are some of the reasons:
      1. Lack of management software: The initial market ramp for enterprise SSD’s came from early adopters, primarily high performance computing customers who live and die by speeds and feeds (the same guys who initially drove every cutting edge technology like FC, IB, 10G Ethernet, Blade servers, etc), who are happy to experiment on their own and make bleeding edge technology work in their data centers. STEC and their OEM partners also probably benefited from a lot of customers buying pilot installations. However, the hockey stick ramp comes from main stream adoption where system administrators want management software such as automatic data tiering that will automatically move hot and cold data between the various tiers of storage. Unfortunately, among STEC’s partners, only Compellent (CML), which is too small to make a difference for STEC has such software in their arrays. While IBM has a semi-automatic migrator in the SVC product just released in November, the fully automated “Automatic Data Relocation” will not be released till 2010. EMC’s initial version of automated tiering called FAST v1.0 is expected to be released any day now (probably this month), while the more granular, block-level version (v2.0) is not expected till later in 2010.
      2. Heavily over priced: At the same time these OEMs are trying to create this market, as only vendors like EMC and IBM can do, they heavily over priced enterprise SSD’s in the market place. In their defense, it is hard and takes time to figure out the price elasticity of a brand new product with such incredible performance improvement and value proposition and so it is always best to price high and then come down to figure out the optimal market clearing price. The list price of an IBM 69GB STEC based SSD is $13,235. At a typical 35% discount, IBM is selling to the end user for around $8,600. The IBM 69GB SSD is actually a STEC 128GB SSD that IBM formats down for wear leveling. Using the spot $4 price for the SLC NAND and my estimates for the cost of the Xilinx FPGA, other components and manufacturing and other fixed cost allocation, I estimate that STEC’s cost for the 128GB drive is around $1,000 and I estimate that in Q3 2009 they sold it to the OEMs at a 60% gross margin or around $2,500. This means IBM is making a whopping 71% gross margin at an end user price of $8,600. While customers have always been willing to pay a premium for performance (a SAS drive can be 2 to 3x the price of a SATA drive), the current premium for enterprise SSD’s is probably way too high to bear except perhaps for some of the high performance applications on Wall Street for instance. Since EMC takes so much of their cues from the financial services industry (their largest vertical), it is possible that they extrapolated demand based on the successes and price elasticity in that vertical which probably did not pan out as expected.
    Finally, in the case of EMC, since they experienced a 160%+ growth in SSD’s in Q2 over Q1, they were probably concerned about going into allocation with STEC in the second half (especially with IBM rolling out STEC based SSD’s) and decided to go with a large $120 Million order.
    1. Concern over management integrity and credibility: Whether management knew about the demand/inventory issue in advance or not, the market found it too coincidental that top management made such a substantial sale of stock in the very quarter they blew up. At the same time the potential question of integrity was being debated, they made it worse in the earnings conference call by not appearing to have concrete answers about the inventory at their largest customer who will generate over 60% of the revenues in the second half.
     
    Where do we go from here?
     
    From a fundamental standpoint, all of the reasons I have articulated previously are still intact:
    1. The market is much bigger than anyone is projecting. There has always been a big gap between the expensive, high performance, but non-persistent DRAM cache and the inexpensive, highly persistent, but low performance spinning hard drive. SSD’s fill this gap and over time every enterprise storage array and high end servers will have some SSD storage standard. This is a secular shift and we are in the early stages.
    2. The enterprise SSD is not a commodity and STEC is the technology leader. The NAND chips that go into an enterprise SSD is a commodity and the hard drive that the enterprise SSD is replacing is a commodity, but the enterprise SSD is not. The intellectual property in an enterprise SSD is in the controller and a lot of sophisticated firmware goes into it to realize the right balance of performance and longevity, while ensuring the utmost level of reliability, availability and data integrity. STEC has been it at it longer than anyone else and those years of production burn time in the field keeps them well ahead of the competition. In my experience with similar products requiring many 9’s of reliability, anyone can create a product with 99.9% reliability within 12 months. However, to add each extra “9” of reliability can take as much as 6 to 9 months or more and requires a lot of field time to get there. Witness the number of high severity firmware bugs Intel SSD’s have had just in the last 12 months.
    3. The competitive concerns are over blown. While it is certain that every OEM will have a second source, it can take a long time to qualify, test and benchmark a new product at a tier-one OEM. Enterprise OEMs like EMC and IBM know my previous point that just because a startup like Pliant or a major vendor like Seagate has released a product, it still takes a long time to get the five 9’s or more of reliability. Finally even when the second sourcing happens, the impact of the second source will be minimal to STEC over the long term.
     
    Unfortunately, these points were valid even prior to the blow up last week. The stock is weighed down by uncertainty over the revenue run rate, growth rate and margins. Valuations are meaningless (7x consensus 2010 EPS estimate of $1.90) when investors do not believe the numbers. Technically the stock is broken and unfortunately fundamental investors will not support it till the uncertainty starts to improve.
     
    Q4 is more or less meaningless at this point (because EMC is sell-in and already baked in at around $66 Million gross) and the focus will be on the direction of Q1 and full year 2010 estimates. Currently, the range for Q1 is $0.29 to $0.45 with an average of $0.38. The range for CY 2010 is $1.50 to $2.45 with an average of $1.90. The question is over the next few months whether Q1 consensus will start drifting closer towards $0.29 or move north towards $0.45.
     
    While it is still too early to call, my feeling is that it is less likely to move towards $0.29 (which implies around $80 Million in revenues, with EMC likely around $40 Million or less and an overall 48% gross margin). Note that the consensus for Q1 is still not yet firm because not all 12 or 13 analysts have logged in their Q1 estimates yet. I believe that Q1 has a better than even chance of exceeding the consensus. Most importantly, EMC will have to fix their inventory issue and get a grip on steady state demand and growth rate. Here’s why I believe we will get there in the next few weeks:
     
    1. EMC will flush the excess inventory: EMC is notorious about using all means to work off excess inventory. This time is no different. But more importantly, this is not a matter of just excess inventory for EMC. EMC has been behind solid state for a long time (the last time was in the late 90’s but the economics were not on their side then as it is now) and they will put all their might behind this to make it succeed this time. An EMC sales rep can sell dozens of products in a quarter to meet his quota and earn his commission. Thus it is amazing what a little bit of management focus (make it mandatory to quote SSD’s on EVERY Symmetrix or high-end Clariion sales opportunity), management monitoring, price cuts and targeted sales “SPIFFs” can do to move a particular product. EMC is doing all of the above for enterprise SSD’s this quarter. As illustrated earlier, there is such a price/margin cushion that EMC can cut prices by 20 to 30% or more and still make very good margins (they will most likely start with smaller price cuts). On the sales SPIFFs, STEC is generously helping out. STEC announced that their MDF for Zeus IOPS in Q4 will be $2.4 Million. I have no idea how this will be broken down. For the sake of argument, assume that around $900K will be spend on marketing programs (brochures, seminars, webinars, lunch & learns, etc) and the remaining $1.5 Million all for sales SPIFF’s. Assuming STEC does $75 Million in Zeus IOPS sales in Q4 and the OEMs sell it at a 50% gross margin – that is, $150 Million to the end users – the $1.5 Million translates to 1%. For an enterprise hardware sales rep making say, 3 to 4% commission at quota, an extra 1% is at least 25% or more in take home pay for the quarter. Sales reps are coin operated and they will figure out every way to move this product. Based on this I believe that a substantial portion of the EMC inventory will be worked off in Q4 itself, and I estimate that normalized run rate revenue from EMC in Q1 will be around $50 Million.
    2. Other OEMs will improve sequentially from the Q3 low: While the SUN situation will continue to hurt for the foreseeable future, I think IBM can show good sequential improvement with the new DS8700 storage array released in late October, the new SVC in early November, and the new p595 in late Q3 all with STEC drive support. Note that the STEC MDF is available to all OEMs and it is very reasonable to assume that MDF will continue into Q1. Other new OEMs like LSI are just starting to kick in.
     
    While it is difficult to call the short term with all the uncertainty over this, and I concede that there is nothing preventing it from dropping few more points on a technical basis, I believe that this stock can be a good investment with a 6 to 12 month time horizon.
     
    I believe that STEC has earnings power of around $2.25 in 2010 and $3 in 2011. That is a 36%+ growth rate over the next two years. Unfortunately, STEC has never enjoyed a P/E multiple befitting their perceived growth rate in the past. If they can start getting a valuation multiple that reflects their growth rate, this stock can go from being a good investment to a “great” investment. However, that will require some major changes at the Company level. For what it is worth, here are some suggestions for management and the Board:
     
    Organizational improvements:
    1. Improve the bench strength at the executive level: The Company is growing way too fast to be operating with such a small executive staff of a CEO, a CTO doubling as a COO and a CFO. The Company needs to bring in at a minimum a world-class EVP of Marketing, an EVP of Field Operations, and a General Counsel.
    2. Improve marketing: This will come from having a good Marketing executive. STEC has less brand recognition than even FusionIO, a much smaller company. If STEC had been doing industry and end user marketing helping end users understand the benefits of using SSD’s in the enterprise and the differentiation of their technology and approach, sales could be much better. This will greatly help the OEMs sales organizations and they expect it from vendors such as STEC.
    3. Improve field operations: While STEC has done a remarkable job in signing up almost every major systems OEM to sell their products, in some respects it is more difficult to retain the OEMs and sustain and grow the revenues year after year in every channel. Competition is coming on strong and they will use every means to knock the incumbent out. This will require getting much closer to the OEM, meeting their every need, exceeding all expectations, helping in marketing, etc which is all about sustaining relationships. While technology and product got you in the door, a dedication to sustaining and constantly improving customer relationships is what will grow the OEM revenues. In fact, if STEC had that, we probably would not have had the “surprises” last week.
     
    Improve Board governance:
    1. Make the Board more independent: Of the 7 member Board, only 3 members, namely Mr. Bahri, Mr. Ball and Mr. Witte are really independent members. Mr. Moses was the previous CFO of STEC and is not independent as acknowledged by the Company. Mr. Colpitts is considered independent by the Company according to its 2009 Proxy Statement as follows: “In determining that each of the non-employee directors is independent, our Board of Directors considered, among other things, the types and amounts of the commercial dealings, if any, between us and the companies and organizations with which the non-employee directors are affiliated. In making this determination, our Board of Directors considered the fact that Mr. Colpitts is the Managing Director and Global Head of Technology Investment Banking at Deutsche Bank. STEC engages a different division of Deutsche Bank to provide cash management services. The fees paid to Deutsche Bank for cash management services do not benefit the investment banking division or Mr. Colpitts. Our Board of Directors determined that this relationship would not interfere with the exercise of independent judgment by Mr. Colpitts in carrying out his responsibilities as a director.” However, Deutsche Bank’s Investment Banking unit was the lead underwriter for the recently completed secondary offering and unless Mr. Colpitts has changed jobs, he does not now qualify as an independent Board member by STEC’s own definition. The Board should be reconstituted to be comprised of a majority of Independent Board members.
     
    1. Add Board members with more industry and executive background: There are currently no non-employee Board members with background in operating enterprise IT companies and no Board member with experience in running publicly traded companies as a CEO. It would be a positive to have Board members with relevant industry experience and CEO experience who can coach and mentor Mr. Manouch Moshayedi.
     
    1. Separate the role of CEO and Chairman: Much has been written on this subject over the last few years, but especially in light of the concerns the investment community has about the integrity and credibility of the management team, it will be a good idea to bring in an independent director as the Chairman of the Board.
     
    1. Eliminate poison-pill provisions in the Company charter: Below is an excerpt from the Company’s latest 10Q that the Board could address in fixing:
     
    “We have taken a number of actions that could have the effect of discouraging a takeover attempt. For example, provisions of our articles of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders. These provisions also could limit the price that certain investors might be willing to pay in the future for shares of our common stock.
    These provisions include:
     
     
    •
     
    limitations on who may call special meetings of shareholders;
     
     
    •
     
    advance notice requirements for nominations for election to the board of directors or for proposing matters that can be
    acted upon by shareholders at shareholder meetings;
     
     
    •
     
    elimination of cumulative voting in the election of directors;
     
     
    •
     
    the right of a majority of directors in office to fill vacancies on the board of directors; and
     
     
    •
     
    the ability of our board of directors to issue, without shareholder approval, “blank check” preferred stock to increase the
    number of outstanding shares and thwart a takeover attempt.
     
    In addition, provisions of our 2000 Stock Incentive Plan allow for the automatic vesting of all outstanding equity awards granted under the 2000 Stock Incentive Plan upon a change in control under certain circumstances. Such provisions may also have the effect of discouraging a third party from acquiring us, even if doing so would be beneficial to our shareholders.
    ”
     
    Finally from a tactical standpoint it will be a good idea to reinstate the stock buyback. There is still $5 Million of authorization remaining from the previous repurchase plan. The Company has $133 Million of cash on the balance sheet and is on track to generate another $30Million+ of cash flow in Q4. It will be a good idea to expand the stock repurchase plan by at least an additional $25 to $30 Million. The number could be higher but I have no idea how much of the cash is in the United States versus in other countries.
     
     
    Price
    Shs Out
    Mkt Cap
    Float
    LT growth
    Cash/shr
    Oper Mgn
    $13.50
    52.2MM
    $705MM
    63%
    30%
    $2.55
    31%
    2008A eps
    2009E eps
    2010E eps
    P/E 09E
    P/E 10E
    Revs 10E
    EV/10Rev
    $0.31
    $1.65
    $2.25
    8.2x
    6.0x
    $480MM
    1.2x
     
     
     
    Disclosure: Long STEC
    Tags: STEC, EMC
    Nov 16 01:11 am | Link | Comment!
  • STEC - Q3 2009 Earnings Preview and Competitive Outlook – Part II
     
    I am forecasting STEC to generate $104.5 Million in revenues in Q3 and an EPS of $0.52. This compares to consensus analysts estimate of $96.6 Million and $0.47. For the fourth quarter, I expect STEC to do $119.5 Million and $0.60/share versus consensus of $106 Million and $0.52.
     
    Anecdotal evidence from STEC’s large OEM’s such as EMC and IBM certainly support the view that Q3 and Q4 will be very good for STEC. While EMC will not release Q3 earnings till October 22, anecdotally, the Symmetrix V-Max storage array has been selling very well and I estimate with a very high attach rate with STEC drives. The financial services industry has also been strong for EMC in Q3 which also bodes well for STEC as this industry tend to buy a lot of Symmetrix and high end Clariion for high performance applications that benefit greatly from SSD’s. Looking out one quarter, EMC and thus STEC will be a big beneficiary from the Q4 budget flush.
     
    As to IBM, on their earnings CC on October 15, the CFO mentioned that they gained 5 points of share in System p. As I mentioned in my article (http://seekingalpha.com/article/165456-promising-future-for-stec) regarding IBM and STEC, the IBM Power (System p) product line will be a big revenue contributor for STEC. IBM contribution for Q4 will be even bigger for STEC as you will get full quarter benefit from the p595 and the introduction of DS5000 series and the new SVC both with SSD support. The IBM CFO also mentioned in the CC that “our hardware business revenue performance should actually improve going from third quarter to fourth quarter.”
     
    While SUN sales in general is suffering from the Oracle overhang, IBM is taking a lot of share from SUN and so I believe that sequential revenue loss deceleration from SUN will be more than made up by IBM and others.
     
    Another anecdote that gives me increased confidence came from increased revenue guidance from Mellanox Technologies (MLNX) on October 5 with them projecting revenues 12% higher than their previous guidance. Mellanox makes Infiniband and 10Gig Ethernet chips that are used in high performance blade servers and high-end switches. Since these systems are used in high performance, low latency applications such as quantitative market data analysis, high frequency trading, etc, it is fairly certain that the storage that is dragged with these systems will have low latency SSD drives. Mellanox is generally a leading indicator and so this bodes especially well for STEC’s Q4 quarter.
     
    As to margins, I expect overall gross margin to remain around 50% with the increase in NAND prices offset by increased mix of higher margin products and better utilization. R&D spend will continue to ramp on an absolute basis but the operating leverage helps to improve operating margins further.
     
    STEC is expected to report Q3 earnings on or around November 11, 2009.
     
    Notwithstanding the above, the general investor sentiment is that the short term does not matter because STEC will be doomed by competition in the future beginning as early as Q1 or Q2 of 2010. This high risk premium is thus reflected in the uncharacteristically low P/E multiple of just 10x consensus 2010 earnings estimate when consensus 2010 earnings is projected to grow 48% from 2009 and STEC’s underlying market of enterprise SSD’s is projected to grow 55%! I am reminded of Citrix Systems (CTXS) a similarly high growth company during the mid to late 90’s. Despite quarter after quarter of growing revenue and earnings upsides, CTXS stock perennially traded at a significant discount due to the “impending” competitive product offering from Microsoft that would wipe out Citrix. While it took a few quarters, the market eventually figured out that the Citrix product is years ahead of the competition and over time the discount went away. I believe that STEC will go through a similar phase. The company has enough upside earnings power for the foreseeable future and as numbers get raised quarter after quarter and when it becomes clear that the competitive dynamics does not affect this earnings power as expected the P/E will start to expand. Why do I believe this?
     
    1. The market is much bigger than anyone is projecting. While an entire article can be written on this topic alone, the simple fact is that in the enterprise there always has been a big gap between the costly, high performance, but non-persistent DRAM cache and the inexpensive, highly persistent, but low performance spinning hard drive. SSD’s fill this gap beautifully. The adoption of SSD’s to fill this gap is a secular shift and we are in the early stages. OEM’s such as EMC, IBM, etc will sell far more than even the best estimates that the market is projecting.
    2. The enterprise SSD is not a commodity. The NAND chips that go into an enterprise SSD is a commodity and the hard drive that the enterprise SSD is replacing is a commodity, but the enterprise SSD is not. The intellectual property in an enterprise SSD is in the controller and again, while an entire article can be written about this, suffice it to say that a lot of sophisticated firmware goes into it to realize the right balance of performance and longevity, while ensuring the utmost level of reliability, availability and data integrity.
    3. The OEM qualification process is long. As discussed in my September 27 article (http://seekingalpha.com/article/163591-stec-buying-opportunity-competitive-concerns-are-overblown), while it is certain that every OEM will have a second source, it can take a long time to qualify, test and benchmark a new product at a tier-one OEM.
    4. The impact of the second source will be minimal to STEC. This is the most important point I want to cover in this article. Since EMC is STEC’s largest OEM customer and competitive dynamics at this customer will impact STEC revenues the most, let’s try to examine this in more detail. First of all, any competitive SSD product that needs to be qualified into an EMC Symmetrix or the Clariion CX needs to have Fibre Channel (FC) support and currently none of STEC’s competitors have announced a FC product or even a roadmap for a FC product. While the competition has SAS products, EMC supports SAS drives only in the very low end AX4 storage (which does not and probably will not have SSD support). I expect the CX to support SAS drives sometime in 2010, but I believe that the Symmetrix will remain FC for the foreseeable future. Now, for the sake of argument, let’s suppose that a competitor is overnight able to level the playing field with STEC from an interface standpoint by either getting FC support or by EMC supporting SAS support across the product line. Now let’s imagine how EMC will roll out the competitive SSD:
      1. In a round-robin fashion alternate STEC and the second-source SSD in every other Symmetrix or Clariion in the manufacturing line? No chance.
      2. Allow the end customer to choose STEC vs. the second-source SSD at the time of ordering? Highly unlikely. Too many marketing and product support issues and EMC will never risk that.
    So the most likely scenario when EMC does qualify a competitor is to put it on one of the entry level Clariion arrays. It is too risky for EMC to put the competitor’s SSD on the Symmetrix or the high end CX’s as long as STEC is working and is meeting the roadmap deliverables.
     
    Now let’s examine further the softer side of an OEM relationship. An incumbent such as STEC has a tremendous advantage at an OEM and that has nothing to do with the performance or any such technical factors. A product like STEC is custom built for an OEM which means there is a big collaboration between STEC engineers/testers and engineers at the OEM. As long as this relationship is strong, the OEM engineers and marketing people will do everything to make STEC successful. The OEM engineers really does not want to do double work. In fact the OEM engineers will probably go out of their way to let STEC know what the competition is doing, thus allowing STEC to remain competitive.
     
    You may now argue that EMC needs to get a second source qualified to drive down STEC price. Unfortunately, as any small company that has tried to negotiate with EMC has learned, there is no such thing as a negotiation with the house that Egan built. When EMC wants a new price with STEC in 2010 they will ask and they will get it. In fact it is probably already built into the master OEM agreement.
     
    The final argument you can throw at me is the recent Sun Microsystems F5100 Flash Array. Sun already has an OEM relationship with STEC and uses STEC drives in products such as the SUN 7000 series storage products. Yet, Sun decided to engineer their own Flash array as I understand using Samsung NAND and Marvell controllers. My only response is this is why Sun does not make money and thankfully most of the other OEMs are run by business people. While I am not a hardware systems architect, I cannot understand why a 1RU product with a few SFF STEC drives could not have achieved more or less the same purpose as the highly custom, highly engineered, difficult to service F5100 that now require a whole engineering department to support it.
     
     
     
    The Bottom line:
     
    The market is severely underestimating the revenue potential and earnings power of STEC. STEC owns the enterprise SSD space today and even when some competitors finally get qualified in late 2010, STEC as an entrenched player will continue to own 80% of a market that will be $1.5 Billion by 2012.
     
     
    Recommendation Summary:
     
    STEC is the leader in enterprise SSD’s and is one of the fastest growing companies in the technology industry with expected growth of 60%+ in revenues in both 2009 and 2010.With the exception of Netapp, STEC has OEM wins with all the major systems OEM’s such as EMC, Fujitsu, HDS, HP, IBM, LSI,, SUN, etc. STEC’s solutions have an extremely compelling customer value proposition – according to a recent EMC presentation (STEC’s largest OEM), a STEC based tiered storage solution provides 18% lower storage costs, 60% more disk IOPS, 17% less power and cooling and uses 30% fewer disk drives (http://www.emc.com/about/investor-relations/archived-events.htm) . With a large market opportunity that is well over $1.5B, compelling customer value proposition, design-win with all the major OEM’s, minimal competition (heavily overblown as discussed here – http://seekingalpha.com/article/163591-stec-buying-opportunity-competitive-concerns-are-overblown), huge manufacturing capacity to meet the high demand, and low cost operation makes STEC a fast grower for years to come in both revenues and profits. With the stock trading under 10x 2010 earnings of $3.00/share, STEC provides a 100% return potential over the next 12 months. Recommendation: BUY.
     
    Target price: $60 (up over 100%)
     
    Price
    Shs Out
    Mkt Cap
    Float
    LT growth
    Cash/shr
    Oper Mgn
    $24.19
    50.7MM
    $1.23B
    63%
    50%
    $1.85
    31%
    2008A eps
    2009E eps
    2010E eps
    P/E 09E
    P/E 10E
    Revs 10E
    EV/10Rev
    $0.31
    $1.70
    $3.00
    14.2x
    8.1x
    $598MM
    1.9x
     
     
     
    Disclosure: Long STEC stock and call options.
    Tags: STEC, EMC, IBM
    Oct 19 12:57 am | Link | 1 Comment
  • The significance of the STEC-IBM announcement

    STEC     announced today the results of a SPC-1 benchmark that delivered an impressive 300K IOPS performance utilizing STEC drives from an IBM Power 595 system, considered the fastest Unix system in the market. Getting past the marketing hype, the press release (http://www.stec-inc.com/press/articles/STEC_IBM_collaborate_to_set_new_storage_record.pdf) and the references from it provided some significant clues into STEC’s future earnings power and its sustainability that will be very rewarding to STEC investors into the future.
     
    The benchmark IBM Power 595 system was configured with 14 storage drawers each with 6 69GB SSD drives (they are actually 128 GB STEC drives that IBM formats to 69GB for wear leveling) for a total of 84 SSD drives. IBM’s list price per drive is $13,235 and was shown with a typical 35% discount equating to an end-user price of around $8,600. While I have no idea about STEC’s transfer price to IBM, I am going to assume that IBM is making about 50 to 65% gross margin on these drives now (why not?) and STEC gets say, $3000 per unit. That works out to $252,000 in total revenues to STEC for a similarly configured Power 595 system. (If you are curious the total end user cost of the benchmark system was $3.2 Million, with the SSD’s costing $722K or 22% of the total system and STEC’s net using my assumptions around 8% of the total system).
     
    The IBM Zeus opportunity: Most of STEC’s recent high margin Zeus IOPS revenues have mostly been coming from EMC. However, I believe IBM can start adding significantly to this over the next couple of quarters providing tremendous upside potential.
     
    According to IDC’s 2Q09 quarterly server tracker, IBM posted a 53.3% leadership share of the $4.7B non-x86 server market. The new Power systems are certainly helping IBM in the high end. Interestingly, IBM made two field announcements recently that will continue to drive market share for IBM in this segment. One, they announced that customers who buy the Power6 machines today will have upgrade protection to the Power7 machines coming next year. Two, they announced in August a Power 595 server trade-in program that will give customers up to $240,000 if you trade in a Sun Fire F15K for example.
     
    Note that the Power systems got SSD support only in the tail end of Q2 and the Power 595 only in Q3 (though many of the 595’s were probably sold attached to the high end DS8000 storage arrays that had STEC SSD support). So the IBM Power related revenues to STEC started trickling in only in Q3 and it will be probably in Q4 that we will start seeing meaningful impact. Just to get a sense of the total opportunity, if every IBM non-x86 server is sold with 8% of STEC SSD content (whether direct attached like in the above configuration or SAN attached as with a DS8000), the total opportunity is $200Million/quarter. Even if it is only 10% of that, the $20Million/quarter is a meaningful addition for STEC now. To put it another way, if IBM sells just 40 Power 595 in Q4 with fully configured 8% STEC content, that is $10Million (note, that is only $3 Million x 40 = $120 Million of total Power 595 system sales, which is fairly conservative for IBM to do in Q4 where enormous budget flush will take place). If IBM sells another $10Million with the rest of Power 520, 550, 560, 570, etc, that is a total of $20 Million. This does not even take into account the LSI Engenio based mid-range storage arrays that IBM will announce with STEC SSD support. Where I am going with this is that my non EMC Zeus IOPS assumption for Q4 is only $22Million and that is starting to look very conservative (and my total revenue projection for Q4 is already $10 Million above consensus). Just FYI, all of the analysis above does not include revenues from Mach8 that goes into the IBM System x servers.
     
    The Bottom line:
     
    The market (myself included) is severely underestimating the revenue potential and earnings power of STEC. Just looking at the enormous amount of collaborative development and optimizations that OEMs such as EMC and IBM did with STEC, the unit testing and application testing, and the benchmarking and marketing specific to STEC drives means that STEC is entrenched and their earnings power and growth is probably sustainable for a long time. STEC owns the enterprise SSD space today and even when some competitors finally get qualified in late 2010, STEC as an entrenched player will continue to own 80% of a market that will be $1.5 Billion by 2012.
     
     
    Recommendation Summary:
     
    STEC is the leader in enterprise SSD’s and is one of the fastest growing companies in the technology industry with expected growth of 60%+ in revenues in both 2009 and 2010.With the exception of Netapp, STEC has OEM wins with all the major systems OEM’s such as EMC, HDS, HP, IBM, LSI,, SUN, etc. STEC’s solutions have an extremely compelling customer value proposition – according to a recent EMC presentation (STEC’s largest OEM), a STEC based tiered storage solution provides 18% lower storage costs, 60% more disk IOPS, 17% less power and cooling and uses 30% fewer disk drives (http://www.emc.com/about/investor-relations/archived-events.htm) . With a large market opportunity that is well over $1.5B, compelling customer value proposition, design-win with all the major OEM’s, minimal competition (heavily overblown as discussed here – http://seekingalpha.com/article/163591-stec-buying-opportunity-competitive-concerns-are-overblown), huge manufacturing capacity to meet the high demand, and low cost operation makes STEC a fast grower for years to come in both revenues and profits. With the stock trading under 10x 2010 earnings of $3.00/share, STEC provides a 100% return potential over the next 12 months. Recommendation: BUY.
     
    Target price: $60 (up over 100%)
     
    Price
    Shs Out
    Mkt Cap
    Float
    LT growth
    Cash/shr
    Oper Mgn
    $27.75
    50.7MM
    $1.41B
    63%
    50%
    $1.85
    31%
    2008A eps
    2009E eps
    2010E eps
    P/E 09E
    P/E 10E
    Revs 10E
    EV/10Rev
    $0.31
    $1.70
    $3.00
    16.3x
    9.3x
    $598MM
    2.2x
     
     
     
    Disclosure: Long STEC stock and call options.
    Tags: STEC, IBM, EMC
    Oct 07 10:42 pm | Link | Comment!
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