Saturday, August 10, 2013

Fusion-io: No Longer The Belle Of The Ball, But New Management Might Right The Ship

Sometimes the hot money on Wall Street gets a little too hot. Case in point data facilitator and accelerator Fusion-io (FIO). Last October, the stock had an outstanding quarter and went ballistic. It reached $32/share based on impressive revenue streams from hyperscale clients Apple (AAPL) and Facebook (FB). These large information sharing platforms where Fusion-io excels, propelled them to international prominence. It now trades at $11.25, and despite the drop in value, still remains an industry leader with disruptive technology.

Fusion-io gets little love on trading floors right now. I'm making an investment in the company not only based on superior technology, but because of a new management team that has the experience to turn things around. Valuation is still steep if you go by a P/E metric, but adding more hypersacle clients can raise those earnings figures (or lack thereof) in a heartbeat. Pandora (P), Alibaba, Salesforce.com (CRM), Spotify, LinkedIn (LNKD) and China Mobile are current customers that are building data centers, and Fusion-io will have an opportunity to deploy there, but not for the next year or two.

I believe it's a management change that is the key for the company to succeed. Back in early May, Fusion-io founder David Flynn resigned as CEO to pursue entrepreneurial investing activities. Mr. Flynn did a great job of guiding Fusion-io through its early stages, but perhaps wasn't the right person to lead a larger entity. This happens a lot in business. Not everybody is equipped to be a Bill Gates or Steve Jobs. In steps Shane Robison, an old pro who was formerly at Hewlett-Packard (HP) in the position of Chief Strategy and Technology Officer from 2002 to 2011.

This past quarter, 2013 Q4, was light, but since Mr. Robison has been at the helm only three months, I am giving him the benefit of the doubt. There were channel conflicts with the OEM's in Q4, and although those conflicts may have begun under Mr. Flynn's tenure, it is Mr. Robison who is now responsible for the mishaps. He discusses this at various points in the Q&A session during the conference call:

  • "The kinds of channel conflict challenges that we've been having have to do with first, pricing. We've been inconsistent in how we priced our direct products relative to our OEM products. And we have to have very clear discipline about how we price our direct sales products, and how we price relative to what we're doing with the OEMs. So obviously, that's an easy thing for us to fix, and we will fix it."
  • "Our ioControl product, which is the new name for NexGen, is now mature enough that it's really starting to get traction in the mid-market, and it will be exclusively sold through the value-added reseller channel. There's been a lot of question about channel conflict with our enterprise customers, and we're determined to eliminate that. So as we go into the second half of this year, we'll rebuild our OEM relationships."
  • "When we talk to our OEMs about qualifying products, their qualification cycles sometimes take several months. And we'll go have a good discussion with the OEMs, get them to agree to qualify our products, they're working away on qualifying the products. And then all of a sudden, we pop up with an announcement in the market and pre-announce that product, which is very disruptive for them. And it's the kind of channel conflict that destroys relationships. We will fix that."
That's no way to run a railroad, especially when the OEM's in question may be Cisco (CSCO) and NetApp (NTAP). However, the new CEO is taking steps to correct the issues.

According to the conference call, IDC predicts that by 2016, the enterprise segment, which is what the OEM's are targeting, will be $78 billion. This is also referred to as the optimized server segment. The hyperscale market, where Fusion-io's direct sales team concentrates on, is purportedly going to grow to $43 billion by 2017. Although these lofty projections by data research companies often fall short of forecast, it is still a significant opportunity.

It wasn't just the weak quarter that hammered the stock. It was lowered guidance for fiscal 2014. Previously, Fusion-io expected 30% sales growth for next year, but has since calibrated that number to 20%. It came out of the blue, and put a black mark on their record. However, they are still selling products, albeit with concerns about slumping margins and pricing pressure. They did $432.8 million in sales last year. Tack on 20% for next year, and you've got over half a billion in revenues going forward.

They are also losing money, $.03/share for Q4, and aren't projected to earn much for 2014. The number I looked at from Credit Suisse is an estimate of $.09 from July 2013 to July 2014, with a loss of ten cents a share for the current quarter, Q1 2014. Credit Suisse maintains an outperform rating on the equity, so take that nine cent gain with a grain of salt. They could keep losing money for the next year, but with $238.4 million in cash and cash equivalents, they won't be going bust.

I've written two previous articles on Fusion-io cautioning investors about the overvaluation of the equity, one last August, the other in November. On a P/E Basis, I still feel the same way, but this a young growth company and other econometrics can be applied: Price/Sales is 2.57, Price/Book is 2.24, Cash/Share is $3.61. Not very expensive despite the lack of earnings. That's my train of thought, and may also be on the same wavelength of possible suitors.

Mergers and acquisitions are on the rise in the bull market. There's a lot of fat cat companies looking for canaries, and Fusion-io would be a nice quarry for one of those slow tech growers like IBM (IBM), Intel (INTC), EMC (EMC), or, Oracle (ORCL). Charity begins at home, so let's not forget that besides Apple and Facebook, Hewlett-Packard is also a hyperscale client of Fusion-io. They could be a possible suitor. So could OEM partners Cisco and NetApp.

I don't know what the downside is for this stock, but I do know that at my purchase price of $11.36, I may make a 20% gain in the next twelve months. That's not insignificant when you compare it to what a certificate of deposit is getting you at the bank. A 20% gain would equate to roughly $13.50/share by August of next year. I think that's manageable. However, we are near market highs in an incredible year, September is historically a bad month, and the company could come up short on that 20% revenue growth in the near term, so you may find a better entry point.