Why Quantum Corp Is a Favorite of Mine

Includes: DVMT, QTM
by: Joe Feshbach

Quantum Corp. (NYSE: QTM -$2.51)) is the leading independent global player in backup, recovery and archive. The company also has a mature though highly profitable business in tape-based backup products and a hot new offering in the most important new product category in storage – de-duplication.

Its history is rife with disappointment, its recent results have been somewhat erratic, its balance sheet is leveraged, it was recently divorced by a high profile strategic partner and is just now emerging from a self-initiated revenue contraction that spanned nearly three years. These issues have disguised a remarkable transformation from a commodity technology provider in a mature market to a high-margined leading edge competitor in a mission-critical segment of information technology.

In my opinion these “issues”, all largely behind the company, have created a remarkable disparity between price and value. I would posit that QTM is worth at least $5 dead and has the potential to be worth far more if it fullfills its potential in de-dupe.

Amongst its many important steps in creating value, QTM walked from low-margin OEM relationships that were text-book examples of profitless prosperity, wisely sacrificing revenues for profitability. It has relentlessly cut operating costs to maximize profitability from its mature tape business. The Company has markedly improved margins in its service business by dramatically improving product quality. It has built its own branded offering so that it now represents 75% of its overall revenues and nearly 100% of its de-duplication offering.

In the next quarter or two the company is poised to show its first quarter of y/y revenue growth in three years, albeit at significantly higher gross and operating margins all the while generating significant free-cash flow resulting in rapid deleveraging of the balance sheet. Finally, it is building a very valuable franchise in de-duplication where it is second only to EMC in that category today.

As a reminder, Quantum sells tape-based back-up solutions including tape libraries, tape drives and media. It is the owner and developer of the LTO and DLT intellectual property which it in turn licenses to the industry in exchange for a royalty stream. It provides a high margin service offering primarily centered around warranty protection for its tape products. From a future growth perspective its biggest opportunity is in its offering of disk-based software used for de-duplication, a technology that improves storage efficiency by 10x or more.

The following catalysts combine to present a near-term trading opportunity as well as being important drivers of longer-term value creation:

New Product Cycles

  • An important new product cycle in de-duplication addressing the mid-market (Network Area Storage or NAS) with is the DXI 6500 product line. Channel checks indicate a strong response from customers and channel partners as these products represent the first viable mid-market alternative to the EMC/ Data Domain offering previously dominant in the space.
  • New tape automation products that address both low-end (recently launched) and high-end users (to be released for general availability in the next few months)
  • A new generation of LTO technology that will be supportive of its high-margined tape royalty stream just now being released into the market.

Continued Improving Margin Trends

  • Non-GAAP gross margins are poised to rise from the mid to high 40% range to over 50% as its branded business grows as a percentage of the overall and de-duplication and other disk-based software and solutions grow in importance as well.
  • Operating margins should expand as the company’s revenues return to growth against a much more controlled cost structure leading to significant leverage in operating profit.

New OEM partnerships:

  • QTM recently acknowledged that it signed a new OEM relationship in its de-duplication product line, awaiting its new partner to announce the relationship in the next few months. Speculation in the industry is that the new partner is Fujistu (OTCPK:FJTSY).
  • Additional partnerships could develop with the likes of Symantec (NASDAQ:SYMC), NetApp (NASDAQ:NTAP)and others.

Upside Surprises For Revenues and Earnings

  • Last quarter QTM reported $.07 in non-GAAP earnings. These results were depressed by approximately $.03 in unusual charges. Given that street estimates are $.04 for the current quarter, the bar is very low to produce upside in earnings for the March quarter.
  • For FY March 2011 the company easily has earnings power of $.40 or more compared to street estimates of $.33.

QTM is likely trading at a low single digit multiple to its earnings power two years out, and is super cheap based on its recently reported quarters. Its tape business provides strong mid-teen operating margins along with a built-in customer base for its de-duplication offering. Management has already demonstrated its commitment to profit and cash flow and will soon add revenue growth to the mix. QTM is another of my favorite ideas.


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