Cray: Even More Upside?

| About: Cray Inc (CRAY)
This article is now exclusive for PRO subscribers.

Much of today's world is about information processing. You can encounter difficult calculations in each and every industry. Healthcare, finance, industrial production and even marketing use complex formulas and work with a huge amount of data. This data has to be stored and processed.

Cray (NASDAQ:CRAY) is one of the companies that operate in this tempting market. It makes supercomputers, helps operate and upgrade them, and is in the Big Data game too. Supercomputers find their work in scientific research, national security and defense, earth sciences, life sciences, energy and manufacturing. Big Data is a collection of data that is so huge that it is impossible to process it with ordinary database management tools or processing applications.

Why is Big Data important? Data sets grow every second. Ordinary solutions that you can use on your PC don't work. You need clusters of processors and special software. The more data is collected, the more the need for it to be stored and processed.

The competition is severe. IBM (NYSE:IBM), Hewlett-Packard (NYSE:HPQ), Silicon Graphics (NASDAQ:SGI), Bull, NEC, Hitachi and Fujitsu have their HPC (high-performance computer) and big data solutions.

What does the stock market tell us about supercomputers?

Starting December 2012 at $14.44, CRAY has risen more than 40%. Let's compare this performance to the performance of the direct competition. Silicon Graphics started December 2012 at $8.47, and it took the stock three and a half months to increase more than 85%! Silicon Graphics' stock was also helped by the news of the $15 million stock repurchase plan. BULL, which stock is traded on NYSE Euronext Paris, showed similar performance, adding more than 40% since December. All those moves happened on increased trading volumes, which is a sign of interest from institutional buyers.

I would not compare CRAY's performance to bigger companies' stock performance because their stocks depend on a variety of other business factors that are not connected to supercomputers or data storage and processing.

2012: the year of the breakthrough

Last year was successful for Cray. Revenue increased by $185 million compared to 2011 and resulted in a total $421.1 million. Such a big increase is a result of two big sales. One sale was made to the National Center for Supercomputing Applications at the University of Illinois and another for the Oak Ridge National Laboratory. This shows us the structure of the high-performance computing business. When it comes to selling really big systems, one sale can decide whether you are profitable for the year or not. A small number of significant contracts makes up the majority of total revenue.

The company expects the revenue to be $500 million in 2013, and operating expenses to be at $160 million. Of course, this estimate depends on the ability to secure new big contracts. As you can see, operating expenses are projected to be much less than the revenue. This means a reserve in terms of being able to stay profitable.

How much upside left for CRAY?

Even given the stock's good recent performance, it has seen better days than this. Back in 2003 it was as high as $55.96, more than 2.5 times its latest price. Then came a painful period of disillusion. It lasted for almost nine years, and now it seems the company has something to show for investors.

Why can CRAY go higher? There are a number of reasons for that.

1) The first one is that the company is finally profitable. Losing money is not the way a business should be done, because someone would have to pay for the losses. In most cases, the unfortunate one is the investor. While it is considered normal to speak about prospective results and ignore the data about losses in tech-heavy companies, I don't think it is an excellent way for long-term investing. Future results are based on today's, and the first important step for a good business is to make ends meet.

2) The market seems to be ready. While it is always difficult to predict, recent developments show that nowadays the technology meets the market's needs. There is a lot of data in the world, a lot more than we had in the early 2000s. This data comes in huge amounts and speeds, and should be processed. HPC clusters are no more government geeks' toys, they are a necessity for some organizations.

We can be present at a new step for the market when one business implements an HPC and/or data storage and processing solution and gets an edge, and the others have to do the same just to level the playing field. That's how market growth is made.

3) Cray's flagman supercomputer Cray XC30 is probably the best in its category. It is a new release and gains popularity. Cray's Big Data product, uRiKA graph appliance, seems to do well too. Revenue from Storage and Data Management business unit increased from $7.2 million in 2011 to $50.2 million in 2012.

4) If CRAY just mimics SGI's performance, it would mean roughly 25% upside. If CRAY returns to the "high hopes" period of 2003, it would lead to more than 2.5 times increase in price. The difference is that at present the supercomputers and Big Data solutions turn from sci-fi to mainstream.

5) P/E Ratio is 4.42 now. If it is to become 10 (which is still conservative), it would lead to stock trading above 47.

Risks are here, too

There are risks with no opportunities, but there's certainly no opportunity without risks. Cray is not an exception to that rule.

1) The stock has risen 40% without a pullback. It could not be suitable for all investors to jump in at current prices. Some would certainly prefer to see a little correction before considering the stock for their portfolio.

2) Supercomputing business is like hunting in a forest where only big animals live. If you shoot the animal, you can thrive for half a year. If you miss, problems are around the corner. The result of the year depends on the ability of CRAY to achieve big contracts. Even one less contract would mean a lot to the valuation of the company.

3) Competition is always present. What is top-notch today may not be so tomorrow. Supercomputer has a long life cycle. You cannot afford to buy a new one every two years. It means that you would try to search for the top solution, so that it would not be outdated for as long as possible.


Given all of the above, should you invest in CRAY? In my opinion, CRAY presents an opportunity to invest in a mature technology in a rising market. I expect HPC and especially Big Data to grow substantially in a five-year period from now. An investor should bear in mind the fact that the stock has risen more than 40% without any pullback. Such an increase certainly lifts up the chances of a moderate correction in the short term, especially if the stock market fails to pass historic highs. Adding the stock to a portfolio at current levels is not for everyone, although the stock is attractive.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.