Is OCZ Worth your Money?

By Keki Fatakia - July 17, 2012 | Tickers: AMZN, FIO, LSI, OCZ, VMW | 0 Comments

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OCZ Technology Group (NASDAQ: OCZ), whose products mainly include solid-state drives (SSDs), came out with a wider than expected fiscal first quarter loss, even though it did report a robust growth in revenue. Since then, Wall Street gave a severe pounding to the stock price. So is Wall Street’s reaction to OCZ’s performance justified?

Well, let’s take a brief look at what OCZ produced in its first quarter results...

• A 54% revenue growth from the prior year period amounting to $113.6 million. This was mainly on the back of robust demand for its SSD products from enterprise customers and OEMs.
• Bookings amounted to a record $140 million.
• Gross margins increased from 20% in the prior year period to 25% this quarter.

So what was the problem?

• While overall revenue may have grown, revenue from EMEA regions seems to have slowed down. 
• The company posted a narrower net loss of $6.3 million against the $9.1 million a year ago, However, this was still wider than what analysts expected.
• Operating expenses more than doubled to $41.3 million mainly due to higher marketing, research and developmental expenditure. 
• A seemingly temporary supply shortfall of power regulators also added to the rising operating expenses.

But do these negatives alone warrant such a huge plunge in OCZ’s stock price? Maybe not. Let's dig a little deeper...

Show me the cash, dude

OCZ might be growing at a fast pace, but it's also burning a lot of cash in the process. The following table shows extracts from OCZ’s cash flow statement and balance sheet.

Source: Google Finance and Yahoo Finance (figures in $ millions) 

As you can see, the company is raising funds through the sale of common stock and is losing a lot of that money primarily due to working capital requirements. Even worse, OCZ's operating activities for the latest quarter saw more than twice the cash outflow compared to the prior year period. But it's not just the cash burn. The constant issuance of common stock is also leading to some amount of equity dilution as well.

When a company issues more shares, the proportional ownership and earnings per share of existing shareholders decline, thus reducing the value of each share – leading to what is known as equity dilution.

Little wonder that at least five brokerage houses, including Piper Jaffray, cut OCZ’s stock price estimates. This in turn gave short sellers a great opportunity to trigger a bloodbath.

But having said all this, let’s not ignore the company’s underlying strengths.

Inner Strengths

OCZ isn’t just another run-of-the-mill SSD manufacturer. In a crowded SSD market, technological expertise and vertical integration is what’s keeping the company racing ahead.

For instance, OCZ managed to bag a VMware (NYSE: VMW) ready status for its high performance Z-Drive R4 it launched last year. VMware is a company specializing in cutting-edge virtualization software. So the certification means that OCZ’s drives are capable of integrating and working efficiently with VMware server and cloud infrastructure products.

At present, VMware is planning to take on the Amazon’s Web services and Google’s Compute engine with a similar offering. So this recognition from VMware could possibly translate into more business from the company itself. But on the whole, the endorsement should boost sales of the high margin Z-Drive, which caters to a $23 billion SAN replacement market.

Besides that, OCZ’s recent acquisition of NAND controller maker Indilinx gives it the ability to develop and produce its own SSD controllers instead of depending on external vendors such as LSI Corp. (NASDAQ: LSI). LSI, also a competitor in the SSD space, recently acquired SandForce Inc, the maker of flash storage controllers, earlier this year.

OCZ used to realize about 20% gross margins when it made SSDs that used SandForce controllers. But now that it has acquired Indilinx, it enjoys about 40% gross margins on its cutting-edge Vertex 4 SSDs, which use Indilinx controllers.

So given the underlying strengths of OCZ and the steep correction in the stock price, is this a great opportunity for those who wish to enter the stock?

The Foolish bottom line

Well, while profits might remain elusive, gross margin and revenue growth do point in the right direction. But I’m a little worried about how OCZ is burning cash and issuing more shares, leading to equity dilution in the process. 

But apart from that, I see a good potential upside from current levels - that's if the company continues to expand revenue and gross margins. Plus, with a market capitalization of around $300 million, I also see OCZ as a potential takeover target from larger players such as Intel, or even the hard drive behemoths Seagate and Western Digital. 

So what do you think about OCZ’s potential? Feel free to express yourself in the comments section below.

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