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Stan Piland
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Stan Piland is a private investor with over 20 years experience in institutional equity sales and trading. His portfolio is actively managed, and he employs a multidisciplinary strategy incorporating elements of both value and growth styles. His investment horizon can be anywhere from several... More
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  • Investors Should Buy OCZ Technology

    While shopping at Best Buy recently, I inquired about solid state drives (NYSE:SSD) for a laptop.  The very tech-savvy sales associate guided me to an Intel X25M 40GB SSD.  When I asked if they had any higher-end products, he responded, “No we don’t carry any of the really good ones like OCZ in this store, but we sell them online.”  I checked the Best Buy site and sure enough, Best Buy recently added a broad array of OCZ RevoDrive and Vertex 2 product offerings to its online store. 


    OCZ Technology Group (OCZ-$7.49) was the subject of a scathing SA Instablog a few weeks ago, and the judgment on the stock was swift and harsh.  I respectfully disagree with the authors, and I consider the downdraft in the stock price to be a gift for any investor with a horizon longer than a quarter or two.  Notwithstanding the negative conjecture and innuendo, OCZ has rapidly gained prominence in the enterprise SSD market, ramped up enterprise SSD revenues at a blistering pace, and fortified its IP with two recent acquisitions.   I am a buyer, and I think investors can reap gains of 100% or more over the next 12-24 months.


    San Jose-based OCZ Technology was founded in 2002 with a focus on high-speed memory modules.  Over the past few years, the company has transitioned itself to become a leading provider of enterprise-class MLC NAND -based SSDs and PCIe solutions.  It now employs 380 people in facilities in San Jose and Taiwan, and markets in over 30 countries.  Last week, OCZ reported that revenues for its fiscal year ending in February 2011 were $191.7 mil, up 33.2 % compared to F2010.  The discontinued memory business, which contributed $71.5 mil in 2010, dropped to $37.5 mil in 2011. Most important however, SSD revenues jumped threefold from $43.5 mil in F2010 (Feb fiscal year) to $133.2 mil in F2011. My forecast has SSD revenues growing 133% to $310 mil in F2011.  Moreover, I expect the company to break even this quarter, with profitability ramping through this year and beyond.  My summary estimates and valuations appear below:

     F10AF11AF12eF13eF14e C10AC11eC12eC13e
    SSD Revenues ($mil)43.5133.2312.5390.6439.5 87.1282.6377.6431.3
    Memory Revenues ($mil)71.537.
    Power Supply Units ($mil)28.921.118.420.525.0 21.418.820.124.3
    Total Revenues ($mil)144.0191.7330.9411.1464.5 159.4303.5397.8455.6
    Gross Margin13.0%14.9%22.0%24.4%26.0% 14.6%20.8%24.0%25.7%
    Non-GAAP EPS(0.56)(0.44)0.26 0.45 0.73  (0.65)0.06 0.46 0.80
    P/E  N/A   N/A26.015.19.3    N/A118.714.78.4

    I believe these estimates are almost certainly too conservative. First, the company has guided to $300-330 mil in revenues for F2012.  I think they can beat that.  But more important, the company is targeting 28%-32% long-term gross margins, and I am only modeling 26% in F2014.  As the company continues to ramp revenues and profits, I would expect the stock to be fairly valued around $13-$15 in the next 12 months and perhaps the low $20s in 24-36 months.


    Most 3rd-party research firms such as IDC, iSupply, TrendFocus and Gartner are forecasting annual SSD shipment growth of 70-90% and annual industry revenue growth of 35-45% over the next five years.  Enterprise SSD revenue growth is expected to expand at a 75% annual clip over the next five years.  So what is driving this explosive growth? First let’s look at the broader industry.     The rapid adoption of cloud computing, mobile internet and streaming video has driven a dramatic increase in infrastructure spending to support these services.  All manner of telecom and technology infrastructure sectors are seeing robust sales growth, including managed hosting services, optical networking equipment, application software, and storage solutions.  Ciena’s (CIEN - $27.06) Gary Smith recently noted that streaming video now accounts for 20% of all internet traffic, and these trends show no sign of abating anytime soon.


    Against this backdrop, storage has emerged as a significant bottleneck in the data center. Without getting too technical (admittedly not my strength), as online storage needs expand, the historic solution has been to simply add vast arrays of 15,000 RPM hard disk drives (HDDs).  But HDD technology has not kept pace with rapid advances in multicore processor speeds, and time delays occur each time the read/write head is required to move.  The solution has been “short-stroking”, or storing high-priority data on the outer edges of an HDD in order to minimize latency associated with head repositioning.  It is estimated that as much as 10% of enterprise-class HDD shipments are short-stroked, resulting in significant asset underutilization.


    The emerging solution is referred to as hierarchical storage management (NYSE:HSM) or tiered storage, which refers to a technique to automatically move data between high-speed (high-cost) and low-speed (lower-cost) storage media. For instance, Tier-1 data (mission-critical, frequently accessed data) may be stored on an expensive double-parity RAID (redundant arrays of independent discs), Tier-2 data (lower priority, less frequently accessed) may be store on lower cost conventional storage area networks (SANs), and Tier-3 data (rarely used archives) stored on compact disks or tape.  Software regularly shifts data among the tiers as needed.


     It is within this context that SSDs have an increasingly prominent role in enterprise storage architecture.  SSDs are as much as 10 times faster, are more reliable, run cooler and use less power than the hard disk- based storage commonly used today.  It is rapidly gaining popularity for top tier data storage.  The disadvantages are that SSDs wear out sooner and cost more than HDDs.  Until recently, enterprise-class SSDs used expensive Single Level Cell (SLC) NAND Flash memory exclusively.  STEC, Inc. (STEC - $20.24) is the market leader in SLC NAND-based drives and is a supplier to most Tier-1 enterprise customers.  Privately held Fusion IO is also rapidly gaining prominence in SLC drives.  Multi Level Cell NAND (MLC  NAND - which store more than bit of information per cell) drives have historically been used in consumer applications.  More recently however, advances in Multi Level Cell NAND drives have improved reliability of MLC vs. SLC and at a significantly reduced cost, and they have much faster read times than SLC NAND based drives.  And it is this combination of lower cost, faster access speeds, and improved reliability which are driving broader enterprise adoption.


    OCZ Technology launched its first MLC-based SSD in 2007, and it has emerged as the market leader in MLC NAND Flash-based SSDs.  The second-largest independent SSD company, OCZ has over 300 customers, including major OEMs and Enterprises such as Yahoo!, nVidia, Dell, Advanced Micro and Johns Hopkins University.  Last year it won its first tier-one OEM design win (thought to be Hewlet Packard).  It continues to gain share with the steady introduction of cutting-edge new products, and its products have received numerous awards and recognition from 3rd-party reviewers.   According to company data, 78% of SSD sales are to the High Performance/Servers/Workstation market, 15% Enterprise/Cloud Computing/Data Centers, and 7% Consumer/PCs.  The company believes its most important growth opportunity is the Enterprise-class market.


    As the early mover in MLC-based SSDs, OCZ has also established a differentiated technology leadership position, both in terms of performance and cost.  Its core products use controllers from SandForce and Indilinx, upon which the company layers its proprietary Virtualized Controller Architecture (VCA).  VCA pools the resources of 2 or more NAND flash interfaces, MCPs, Storage Processors and a Physical Interface to provide higher performance by eliminating interface performance limitations. OCZ’s VCA enables clustering of up to eight controllers.  In this light, OCZ’s recent acquisition of Indilinx for $32 Mil in stock in late 2010 was not about acquiring revenues, but R&D capability and Intellectual Property. The company expects the acquisition to be accretive later this year and to improve gross margins by 2%-4% within 12 months. But the acquisition’s most important rationale lies in 20 controller-related patents and patent applications and the accelerated development of next-generation solid state storage solutions.


    Finally, OCZ completed a $94 million equity offering last month, bolstering its balance sheet and fortifying its working capital position (an important consideration in competing for new OEM qualifications).  The company has announced plans to double manufacturing capacity within the next 90 days, which should support over $150 mil per quarter in SSD revenues in the second half of this year.   Current capacity constraints enable the company to satisfy only around 50%-70% of its order/demand backlog.


    Investments in small, fast-growing companies carry certain risks, and OCZ is no exception.  Most notably, competition is pretty stiff, and as new competitors enter the market, pricing is expected to decline.  As noted, OCZ has established a strong position in its niche, and its products compare favorably on both price and performance.  But clearly the competitive landscape needs to be monitored.  Also rapid capacity expansion can bring unforeseen difficulties which need to be monitored.  To date however, execution has been excellent.


    What I do NOT think are risks are of the issues raised in the recent short recommendation regarding the integrity and quality of management.  CEO and co-founder Ryan Petersen’s “youthful indiscretions” have been widely disclosed in SEC filings, meetings, and conference calls.  He now counsels at-risk youth groups, and he has built a remarkable company.  Similarly, CFO Arthur Knapp has been with the company since 2005 and has 30 years of financial experience.  So to me, the M-factor (management) is a distinct positive, and folks, like me, who invest with these guys are likely to be well rewarded.

    Tags: OCZ, CIEN
    May 07 7:53 PM | Link | 3 Comments
  • Buy Quality on the Cheap

    With a double-dip seemingly off the table, it now makes sense to turn one’s attention to recovery stories with a robust internal growth story.  Although its market cap is only $135 million, Quality Distribution, Inc. (QLTY-$6.48) runs North America’s largest bulk chemical tank truck network, with an estimated 14% market share in this $4.0 billion industry. While my target over the next 12-18 months is $12-$15 based on $1.00 in earnings for 2012, I fully expect to see low to mid $20s within the next 3-5 years


    The Quality story has been unfolding for years.  Founded in 1994, the predecessor company was acquired by Apollo Management in 1998 and acquired Chemical Lehman Tank Lines.  Over the next few years, the company changed its name to Quality Distribution and began its conversion to the current asset-light business model, culminating in a moderately successful 2003 IPO. However, it continued to struggle with an excessive debt burden and operational issues until fairly recently.  Gary Enzor was appointed CEO in June, 2007, and under his leadership the company has completed the transition to a high ROIC asset-light business model, divested non-core operations, acquired intermodal container and services company Boasso, and positioned the company for rapid growth over the next few years.


    My estimates and valuations are as follows:


                                        Revenue (mil)             EPS                  P/E

    2009A                          613.61                         .07                   na

    2010e                          692.9                           .42                   15.43

    2011e                          755.0                           .74                   8.76X

    2012e                          791.0                           1.00                    6.4X


    My earnings estimates are above the consensus, but are below the highest estimates.  The difference is mainly that I have somewhat higher operating leverage assumptions.  Key to my expectations is the high return, asset-light business model in which Quality handles marketing and provides sales, back office/technology, insurance support, as well as leased trailers to Affiliates, or owner/operators who own the trucks and terminals.  Under a typical revenue sharing and leasing arrangement, Quality keeps 15% of the revenue and collects an 8% rent on the trailer.  As Quality has over 1000 unused trailers, and each trailer can generate as much as $100,000 per year, there is the potential to grow revenues by over $100 million and operating profits by $15-20 million with little incremental investment.


    Recent performance has been stellar.  Quality has beaten street expectations in each of the last four quarters.  They are expanding market share.  And despite the economic downturn, both EBITDA margins and Cash earnings actually showed year-over-year improvement in ’08, ’09 and 1H’10. Second quarter revenues were up 13.1% and EBITDA improved 34.4%.  Adjusted EPS were 10 cents vs. 2 cents on 2009.  Clearly, the transition is beginning to show some results!


    A risk factor is that Quality still has some fairly expensive debt, specifically $135 million in 10% Senior Notes due 2013 and $81 million in 11.75% Senior Subordinated PIK Notes also due in 2013.  Debt maturities before 3013 are modest.  However, with $58 million in LTM EBITDA and Maintenance Capex running around 1% of revenues, I estimate that they can pay off at least $20-25 million of debt per year from free cash flow.


    The company filed a $65 million share offering last spring intending to reduce debt with the proceeds.  In light of the subsequent market downturn, the stock went from $8 to under $5, and the offering has yet to be priced.  Management appears to be in no rush to price a deal at these levels.  The stock has begun to recover, and the chart is starting to look pretty good.


     That said, the offering still creates somewhat of an overhang, and it is often a thinly traded stock.  So it makes sense to use limits, perhaps buy half a position ahead of the deal, and complete it once the offering is priced.  Given the company’s market position and management’s excellent execution, shareholders should be richly rewarded.

    Disclosure: Disclosure: The author is long QLTY
    Tags: QLTY
    Oct 07 11:55 AM | Link | Comment!
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