Despite prevalent investor sentiment that hard disk drive names represent high-beta, overly-reactive stocks, Deutsche Bank Securities Vice President and Senior Analyst Sherri Scribner says there is more than meets the eye upon first glance at these companies’ investment potential.
“I think there is a perception out there that they are not very good businesses, that they don’t make money and that they’re always in the middle of a price war. I think if you look at the past couple of years, especially since Maxtor was purchased by Seagate, and as I mentioned earlier with the price declines, the business has improved as we’ve seen industry consolidation,” Scribner said. “These companies have been able to improve their returns, and ASP declines have been more modest, so you haven’t seen the kind of aggressive pricing actions for extended periods of time that you used to see prior to the tech downturn.”
Scribner looks fondly upon the balance sheet of Western Digital (WDC), which she says has a good cash conversion cycle and positive returns.
“They’ve been building up their cash levels primarily because they’ve been doing so well in gaining share and generating cash,” Scribner explains of Western Digital‘s healthy cash position of almost $3 billion. “The company has prioritized their spending on cash as, first, to invest in the business, and that would include value-added acquisitions.”
Recent advances in controller and error correction software are expected to increase the adoption of solid-state drives and bring down costs, a senior research analyst at Noble Financial Group says.
“Micron (MU), Anobit, Fusion-io and Pliant Technology … have made significant improvement in what are called three-bit cells,” Mark Miller said. “These developments should increase adoption of SSDs into tier-zero applications.”
Although more than 100 firms market SSDs, the low barriers to market entry have left the competitive landscape especially active, with major companies, such as Intel (INTC), Samsung (005935), Toshiba (6502), Seagate (STX), Hewlett-Packard (HPQ) and Western Digital (WDC), entering or expected to enter the enterprise SSD space.
“Couple these issues with the enterprise storage world moving away from Fibre Channel, which STEC (STEC) dominates, and investors will have to be very careful about being caught up in irrational exuberance about this space,” Miller said.
While several positive secular trends and low barriers to innovation set the enterprise software industry up for accelerated change over the near term, one of the most prevalent IT trends that both consumers and companies will experience over the next decade will be an increase in “transparent IT,” said Edward Maguire, a Senior Analyst at Credit Agricole Securities (USA).
The senior analyst identifies transparent IT as those systems that will increasingly become invisible or embedded into our daily lives.
“One [aspect of this trend] is the idea of how cloud computing creates this almost pervasive resource for data center-level computing, or scalable, extensible and dynamic computing resources available to anybody on demand, whether this be a couple of folks with a credit card looking to test a couple of applications or Web site, to major corporations,” Maguire said.
The analyst points to Salesforce.com (CRM) as a leader in the market for software as a service and platform as a service in transparent IT. He also identifies Red Hat (RHT) as the epicenter of an open source ecosystem that provides the structure for cloud computing.
As many companies exit the recession with strong balance sheets and cash on hand, management teams across a number of industries are now allocating some of their expanding budgets to IT infrastructure updates that may have been neglected during the difficult economic environment of the last two years.
“You can postpone your PC upgrade, you also can postpone maybe some of your software upgrades, but if you are running out of capacity in your storage, you have to buy more capacity,” said Kaushik Roy a senior vice president and senior analyst at Wedbush Securities, who recommends investors take close looks at data center companies with little to no exposure to consumer demand, which remains soft.
“Look at VMware (VMW) — what’s helping VMware are two things: It’s the data center refresh, and it’s the re-architecture of the data center. When you are doing a refresh, you’re re-architecting it, and when you are re-architecting it, you are incorporating virtualization, so that’s helping VMware. That’s why the stock has done so well this year,” said Roy, who also includes EMC (EMC) and Net-App (NTAP) on his short list of companies to keep an eye on.
“So what do we like here? We like companies which have an exposure to the enterprise, especially the storage systems market. We like the virtualization vendors that are participating in the data center refresh and the data center re-architecture,” he explained. “But where we are cautious is on tech companies that have large exposure to the consumer segment.”
Executive turnover has continued to decline throughout the economic and financial crisis and even as the recession ended according to the official proclamation by the National Bureau of Economic Research. Liberum Research’s latest quarterly turnover numbers for CEOs, CFOs, Board of Directors and C-level executives (defined to include CEOs, board of directors, CFOs, COOs, down to VP level) continued to show a drop in turnover for all key categories for the third quarter of 2010. The declining trend in executive turnover has continued since the first quarter of 2008 for all key executive turnover categories (see the CEO, CFO and C-level graphs below for quarterly turnover comparisons). While the first three quarters of 2010 continued to show significant declines in executive turnover, particularly when compared with the first, second and third quarters of 2009, we are beginning to see the overall executive turnover declines slowing when the quarterly figures are compared with each previous quarter of 2010.
While monthly executive turnover numbers have been smaller since early 2008, the investment opportunities they represent are still quite significant. Below Liberum put together three graphs representing the total executive related changes (CEOs, CFOs and C-level changes) by quarter for 2005 through the third quarter of 2010.
In an exclusive free preview of next week’s Data Hosting Centers & Data Storage Report, the Chief Marketing Officer of Equinix, Inc., and a Wall Street Journal “All-Star” analyst discuss the current volatility of data storage stocks with The Wall Street Transcript.
Equinix CMO Jarrett Appleby sits down with TWST to discuss the company’s recent acquisition of Switch & Data and the subsequent integration process.
“The acquisition was built on a common business model and a strong cultural fit,” Appleby said. “Why was this important? Because the continued and rapid growth for online information requires companies to reliably connect and improve the performance of their business-critical content and applications by storing and distributing latency-sensitive assets at the network edge, near local population.”
However, Clayton F. Moran, SVP and Senior Analyst at The Benckmark Company, says that part of Equinix’ downward revision to its second-half guidance last week is due to softness in the Switch & Data portfolio.
“The pipeline of new business has not converted to revenue as quickly as Equinix expected, so initial results from this acquisition are poor, explains Moran, who, despite EQIX’s stock selloff, retains a “buy” rating on the company.
“While we were alarmed at the miss and the explanation, we view the stock selloff as disproportionate,” Moran said. “Macro drivers remain intact, but with a management credibility issue, this stock is likely to linger near term. Our new price target is $83 per share.“
While investor interest in health care IT stocks remains high, along with the confidence levels of the sector’s management teams, Brett Jones, a senior analyst at Brean, Murray, Carret & Co., remains skeptical about whether the high multiples awarded to these stocks based on near-term growth prospects accurately portray the companies’ long-term growth opportunities.
“I am concerned that we’re assigning high multiples due to the near-term growth prospects, and people aren’t looking at what are these companies going to look like two or three years from now, potentially falling into a bit of a trap,” said Jones, who doesn’t believe the 20% EMR penetration level cited by many health care IT management teams to be correct. “I believe there are approximately 200,000 physicians that have an electronic medical record from one of the big primary EHR vendors, meaning that I think these are vendors that will meet the meaningful use criteria, and therefore we count those physicians as having adopted. When I do that, I’m coming up with a market penetration north of 40%.“
Despite his bearish outlook, Jones still sees opportunity for the ambulatory EMR providers, including Allscripts Healthcare Solutions (MDRX); athenahealth (ATHN) and Quality Systems (QSII).
“I believe we can see two years of good growth, and then they potentially stumble from there,” Jones said. “If that is the case, then when should we start to price that into the stocks?”
After the health care stimulus engenders widespread use of electronic medical records, health care IT companies will have to look past domestic markets for growth, Managing Director Gene Mannheimer of Auriga USA LLC says.
“The good news is you have the stimulus, which is the biggest catalyst for health care IT in recent memory,” Mannheimer said. “Once this stimulus is played out, once those EMRs are purchased — 90% of hospitals have them and 80% of physician offices have them — once that takes place, then there really isn’t much more growth that remains, at least domestically.”
Companies that already receive revenues from abroad include Cerner (CERN), which has about 20% of its revenues from international sources, and Eclipsys, which was recently acquired by Allscripts (MDRX) and also has an international presence, Mannheimer says.
Although Mannheimer is cautious on the health care IT sector’s future growth trends, he says a domestic lull will be more of a longer-term concern, adding that for now there is plenty of business for most of the companies in this space.
Despite the negative impact to the earnings multiples of most medical device stocks during the recession, some smaller names with unique products used in non-deferrable treatments have performed well, Piper Jaffray Managing Director Thomas Gunderson said.
“It would include names like DexCom (DXCM), where they have a new continuous glucose management product for diabetics to use at home that is growing significantly,” Gunderson said. “The stock is up over 300% since early 2009.”
Volcano (VOLC), another company with solid growth, has made imaging of the heart’s arteries simpler and more cost-effective for hospitals, the analyst said. In addition, Cyberonics (CYBX) developed an implantable medical device to deal with epilepsy, a condition for which treatment is difficult to put off.
“Some medical problems are more difficult to postpone treatment,” Gunderson said. “The companies that treat these ‘non-deferrables’ have performed relatively better in the recession.”
Now that Nokia has brought on Stephen Elop, the former Microsoft software executive, to be the new CEO, questions remain what he can do to revive the fortunes of Nokia. I have not been one of Nokia’s fans of its latest CEO hire. While Elop is really smart and effective executive, I am not convinced he was the right person for the job. J. Gerry Purdy, PhD the Principal Analyst for Mobile Trax LLC has written a terrific piece in RCR Wireless outlining his ideas on exactly what Elop needs to do to be successful at the helm of Nokia. According to Purdy,
… all is not well with Nokia as you walk in the door. While the volume of cell phone production is very high, it’s clearly not the right mix of models, software and services. And, while you were one of the first firms to develop a smart phone with the N95 in 2006, you have clearly fallen in the fast-growing smart phone segment, especially in the United States. Integrated multimedia smart phones are becoming the dominate handset device type in the developed world, and Nokia needs to get back to creating truly great and innovative products.
… There’s no way around the basic fact that you’ll have to make a number of major changes. You can’t keep designing products the way you have in the past. You can’t keep doing operating system software the way you have in the past. You can’t ignore major changes in the way people use their phones (highly integrated multimedia and almost all oriented toward touch screens). You have to rebuild from the ground up. You have to re-create a culture around Nokia being “cool” again. You can’t simply declare it. Rather, you have to actually do it.
Purdy goes on to make concrete suggestions on exactly what he thinks Elop needs to do including moving the corporate headquarters from Finland to the United States. Many of his suggestions were right on target but the suggested HQ move is unrealistic for such an important Finnish firm. Anyone interested in Nokia or the wireless industry should read Purdy’s entire piece.
