Quantum Corp. (NYSE:QTM) is a provider of scale-out, data protection and archive storage solutions. The company has transitioned the business away from slower growing but cash flow positive tape storage to its rapidly growing scale-out storage business.
Although the company has made strides in addressing its capital structure by refinancing $82 million of convertible notes due November 15, 2015, with proceeds from a bank credit agreement and cash on the balance sheet, $69 million of convertible notes due November 15, 2017, remain to be addressed. With $34 million cash on the balance sheet, Quantum needs to generate or raise at least $35 million to retire the 2017 converts. This upcoming maturity may be causing some concern in the market but I believe an investment in Quantum is nowhere near the distressed situation its equity valuation discounts.
On the FQ1 2017 earnings conference call held July 27, 2016, Fuad Ahmad, CFO, indicated discussions with lenders could lead to a refinancing of the converts in "coming weeks." Over two months have passed since that earnings conference call, yet no announcement has been made. On September 23, 2016, the company announced it entered into an agreement with VIEX Capital, an activist shareholder, whereby it granted two of VIEX's representatives' board observer rights and agreed to hold its annual meeting no later than January 31, 2017. I suspect that the two parties have been negotiating for months and that the agreement and recent positive earnings pre-announcement may clear the way for the closing of a debt refinancing, which could be announced when QTM reports earnings on October 26. The debt refinancing would remove an important overhang from the stock and is a positive catalyst, in my view.
Scale-out Storage Hitting its Inflection Point
Scale-Out Storage Solutions is Quantum's crown jewel. Scale-out addresses the storage of unstructured data, such as corporate, sports and surveillance video as well as scientific research and genomics - all high growth, demanding applications. The company has spent much capital building this business and it may not have been obvious to the casual observer that it has been capital well spent until the October 6 positive pre-announcement. In fact, three years ago an investor may have questioned the risk reward ratio of investing in scale-out, however the investment is now de-risked, given the historical growth trajectory and recent strong pre-announced results. Said another way, QTM investors get the fruits of the company's labor without having to pay up for the certainty that the investment now presents.
Scale-out storage has grown from $53 million in revenue in fiscal 2014 (ending March 31) to $103 million in fiscal 2016 and has finally reached critical mass. In its October 6 press release QTM reported preliminary scale-out revenue of $46 million, up 54% from $29.9 million in the year-ago quarter and up 49% sequentially from the $30.8 million generated in the June quarter! With heavy investment in scale-out largely behind the company, QTM should be able to generate an incremental operating margin of 35-50% on scale-out revenues, which when combined with the high growth rate of scale-out, will bolster bottom line profitability and free cash flow.
Further Appreciation Ahead as Negative Technicals Abate
Quantum was eliminated from the Russell 2000 Index at the June 2016 annual Russell rebalancing, causing index funds and active funds benchmarked against the Russell 2000 to sell tens of millions of shares. Indeed, SEC filings by BlackRock (NYSE:BLK), Fidelity and Vanguard all show sizeable sales. With the stock currently trading below $1.00 many institutions are prohibited from owning shares, so institutional support is nearly non-existent and I am sure recent tax loss selling has not helped matters much. As the end of the calendar year approaches, these technical issues should be exhausted. A reverse split approved at the next annual meeting would allow institutional investors the opportunity to own shares and could send shares higher. We now know that the annual meeting will take place no later than January 31, 2017.
Valuation and Conclusion:
|Annual Revenue Est||Multiple||Value|
|Tape Automation (1)||$80mm||1.0X||$80mm|
|Disk Backup (2)||$45mm||1.0X||$45mm|
|Devices and Media (2)||$35mm||.75X||$26.25mm|
|Net Value Per Share||$1.69|
(1) Although Tape automation is a no-growth business, I value it at 1X revenue due to the high amount of cash flow it generates.
(2) Disk backup and Devices and Media are slow to no growth businesses and warrant a revenue multiple of between .75X and 1.0X.
(3) A 2.25X revenue multiple on the high growth scale-out business is not unreasonable and would amount to $394 million.
With slow to no growth peers trading anywhere from roughly 1.17X to 1.84X revenues, a blended EV/Revenue multiple of 1.62X is a reasonable valuation for QTM. Considering the high growth rate of scale-out and its absolute sales level reaching critical mass, 1.62X may very well be conservative.
|Western Digital (NYSE:WDC)||1.84|
|Seagate Technology (NASDAQ:STX)||1.22|
|NetApp, Inc. (NASDAQ:NTAP)||1.17|
|Source: Yahoo Finance|
Quantum's shares have bounced off oversold levels but much upside exists before getting close to fair valuation. An investment in Quantum shares today is timely, given recent and future catalysts. Valuation is extremely compelling, considering scale-out is now the largest contributor to overall revenues.
Disclosure: I am/we are long QTM.
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.
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