Nearly Quadrupling In 2013, Dot Hill Still Has 2X Potential In 2014

| About: Dot Hill (HILL)

My August 8, 2013 article on data storage device provider Dot Hill (NASDAQ:HILL), Dot Hill Likely To Reach $4 Per Share In 2014, may not have seemed prescient to those who bought HILL in the following few weeks. On the date of the article HILL closed at $2.60 per share. Profit taking and news of patent litigation took the price down to $2.11 by September 16. Given that the 2013 low was $0.88 on January 7, $2.60 may have seemed fantastically high to some traders and investors.

Note HILL is a very volatile, small cap stock, and has had some hard times during the last decade. My prediction of $4 per share in 2014 no longer seems overly optimistic since HILL closed at $3.25 on December 27. Enough new data is in since August that (with the usual caveats) I think by the end of 2014 the value of Dot Hill will likely be in upper end of the range of $4 to $7 per share.

Dot Hill makes small business and enterprise data storage devices, most of which are rebranded and sold through OEMs and system integrators. The demand for storage continues to grow rapidly. Despite its small size, Dot Hill has successfully been first to market with innovative technologies at a reasonable price. As a result a number of new customers were announced in 2013, which should result in increased revenue and profits in 2014.

At $3.25 per share HILL has a market capitalization of $192 million. As of the end of Q3 cash was $40 million and there was no debt. On a one-year retrospective basis the stock price is not justified. The following table shows GAAP and non-GAAP earnings per share (EPS) over the past 4 reported quarters:

Q4 2012 -$0.09 -$0.03
Q1 2013 -$0.02 $0.00
Q2 $0.04 $0.06
Q3 $0.03 $0.05
Totals: -$0.04 $0.08

Even with a rule-of-thumb P/E of 20 and using non-GAAP numbers, we would get a value of $1.60 per share, and another $0.68 in cash, for a total of $2.28.

How well Dot Hill does is dependent on how much product is sold through by its OEM and other customers. Revenues trended up in 2013, from $44.5 million in Q1 to $52.6 million in Q3. Hewlett-Packard (NYSE:HPQ) is the largest revenue contributor, at 58% of total revenue in Q3. For years Dot Hill has been building its base of smaller customers; in Q3 2012 HP represented 68% of total revenue.

Dot Hill can lose customers, of course. Sun Microsystems was once its main customer before being acquired by Oracle (NYSE:ORCL), and later NetApp (NASDAQ:NTAP) was a major customer. Hill terminated its agreement with NetApp because of poor margins.

Dot Hill announced 7 major new customers during 2013: Teradata, CGG, Quantum, Acer, Mega Networks, SYNNEX, and CMS. The timing of the sales ramp for these companies alone should add to 2014 revenues. New products introduced in 2013 should also ramp at existing customers in 2014. An entire set of new customers are also likely to be announced in 2014 (with some ramping, but the major revenue ramps in 2015). Dot Hill is in discussions, or is already engineering systems for more than one new customer in the telecommunications space and a digital image archiving customer, as well as a big data customer that may bring in over $20 million per year in revenue.

Guidance for Q4, 2013 is revenue between $53 and $58 million, with non-GAAP EPS between $0.03 and $0.06 per share. Again using a P/E ratio of 20 and non-GAAP numbers, for full 2013 EPS between $0.14 and $0.17 would lead to a stock price of $2.80 to $3.40 per share. If cash is still near $0.68 per share, that would get HILL to $3.48 to $4.08 per share, without taking any 2014 growth into account.

Of course you can get a lower share price by using non-GAAP earnings or assigning a lower P/E based on any of a number of factors. Missing guidance, or even making it at the low end, would likely result in a price retreat.

Because Dot Hill's operations became very lean during the recession, despite the low margins in the storage industry a considerable amount of any revenue increase should drop to the bottom line. For my own model I am putting the highest probability on EPS of $0.36 per share for the full year 2014. When management reports Q4 2013 results they will issue guidance for the year, and I'll reflect on that. But my model says 20 x $0.36 or $7.20 per share, plus cash per share.

Nevertheless, don't expect the stock price to climb steadily into the $7 range. Because of the giant leap forward in 2013, some investors will be selling at least part of their positions to lock in profits. I am primarily a long-term investor, but I have portfolio rules that force me to sell some of any individual stock that exceeds a set % of my portfolio. That helps manage risk. This means I will likely be selling some of my HILL shares in 2014, if I am right about the stock price appreciation.

I first acquired HILL in 2004 at $7.18 per share (and lost money when I sold those shares). Since then I have taken advantage of volatility to buy and sell shares to my advantage, but increased my stake over the years. I bought as low as $1.05 in 2010. It has taken Dot Hill a long time to turn around. I believe the current stock price fails to take the likely 2014 trajectory into account because of Dot Hill's past difficulties, and because it is small and relatively obscure compared to other data storage providers.

In related positions I also hold Seagate (NASDAQ:STX), which makes some of the hard drives and SDDs that can go into HILL's products, and Marvell (NASDAQ:MRVL) which makes some of the chips that go into hard drives and SDDs, as well as networking products used in data centers.

Disclosure: I am long HILL, STX, MRVL. 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.

Additional disclosure: I will not change my HILL position for the next 72 hours.

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