My Favorite Growth Stock is Going Insane
Nikhil is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Recently, OCZ Technology Corporation(NASDAQ: OCZ) was down 40% from pre-market highs. OCZ shareholders have had an absolutely crazy time recently. After hitting lows in June of 4.2, news started hitting the scene. First, OCZ started securing contracts. Announcements came out about contracts with Dynamite Data and Microsoft(NASDAQ: MSFT) and the stock flew as investors presumably expected something big in the earnings announcement.
If you were planning on buying OCZ on the cheap, things didn't seem great as OCZ went from $4.95 to $6.30 in 3 days. In the next 5 days it fell back down to $4.36 on what was perceived as a weak earnings call. Remember that I wrote another article in the beginning of June on OCZ as "The Cheapest Growth Stock I've Ever Seen," so I decided to look past the press and into why the earnings were so disappointing. I was surprised, though, when I actually looked at the transcript and everything seemed completely fine. The press focused on an EPS miss (they were -.04 compared to analyst expectations), and this is likely because the main bear case for OCZ is a lack of cash flows and liquidity. What the press didn't seem to care about was that revenue expectations beat for next quarter, and 2013 revenue guidance was affirmed. Things just seemed to continue to improve in all areas. Shipments of their new products (Vertex 4 and Agility 4) began late in the quarter, so OCZ expects to see a nice effect on gross margins going forward. They expect to see sales growth ramp higher in the third quarter and they have new customers. On Microsoft, management said it was a significant customer and that Microsoft could grow to become one of their most significant clients. Note that Microsoft had no impact on OCZ's results this quarter, but should provide a boost in later quarters.
OCZ's management clearly seems to know their business well. They've stopped getting NAND Flash from the spot market, where they have to pay a premium, and are instead buying it cheaper and in bulk through negotiations with a number of suppliers, including Micron Technology(NASDAQ: MU). Inventory management is a large reason for why OCZ announced this quarter that it believes it will be cash flow positive by Q4 and continue that into next year.
Why the Volatility?
So again, why is OCZ so cheap? The bear case is simple. OCZ has low margins, they haven't yet been able to produce a profit, and they're burning through cash at a sizzling rate. The fact is, this is all part of management's plan, and OCZ's fate rests on whether this plan works. OCZ's low margins are attributed to it's business. It's in the consumer business, with only small reaches into enterprise markets, and gets lower margins in general because of that. However, even in the consumer business, OCZ has low margins as it fights to take market share. The reason they haven't been producing a profit and they've been burning through cash is the same, OCZ management is thinking long-term. The SSD market is extremely competitive and long-term OCZ sees three possible outcomes: 1) OCZ becomes a huge market leader, 2) OCZ gets acquired by a giant in the area, or 3) OCZ is pushed out by competition and the business decays (worst case outcome). The only way for OCZ to really stay on top in this industry is to have a superior product, so management is investing as much cash as is asked for in product development and product quality. Looking at it in a long-term perspective, OCZ has to invest to survive.
There is no question, however, that OCZ's investments are paying off. OCZ's Vertex 4 drive matches up with the best of SSD's in the consumer markets, and OCZ's new products look to have amazing specs. OCZ has a new controller in the works, Barefoot 3, which should have bring higher performance with cost benefits, and OCZ is developing an internally designed "Aragon 400" 32bit processor. OCZ calls it the "world's first SSD optimized processor," and I can see it being potentially disruptive.
So What Now?
Well, the last week has been crazy, leading me to say that "My Favorite Growth Stock is Going Insane." On July 19th, OCZ shares surged on reports that Seagate(NASDAQ: STX) was looking to acquire OCZ. Shares rose even more, to an after hours high of $8.80 on reports that the deal was done and that we were looking at a price of $1.14B in the acquisition. The acquisition would make sense, OCZ's biggest problem was cash burn and Seagate has cash and a distinct need for solid SSD offerings. After Seagate's conference call had no real mention of OCZ, however, shares dropped to lows of $5.14. Lesson? Don't Buy Rumors. Even so, I thought that since the runup was all based on the foggy rumor of an acquisition, OCZ shares would slip back down to prior lows. Not the case as insanity continues.
Apparently OCZ may be worth something even without the acquisition.
The main news reporter, Bright Side of News, has a new article out saying that the deal might not necessarily be canceled, and emphasizing that deals take time. At this point, I'd avoid buying OCZ on rumors and buy on fact. Even at current prices, I think OCZ is cheap relative to it's overall upside potential. Once OCZ starts getting operating cash flow, fears of cash burn will subside and OCZ should see a clear upwards path. If you buy now, prepare for some serious volatility as I could easily see OCZ hitting $4 before it hits $8 again.
One Last Catalyst
One last thing from the earnings conference call. OCZ's quarterly revenues weren't so great, it was their guidance that beat. Apparently they had some supply chain issues so they were unable to recognize some revenue in the quarter, and that revenue is expected to be pushed over to the next quarter. Here's a clip from the Q&A in the conference call:
Kulbinder Garcha – Credit Suisse
"I appreciate the conservatism. I guess, Ryan, I'm trying to think about if you guys have $27 million worth of almost firm orders that would actually -- that should have been this quarter, they are going to come next quarter, plus you got the underlying business you should be at 140 anyway, right?
And then so, I can kind of think plus your underlying business is growing, PCIe is going to grow a little bit you're saying and then do you just got growth in the end market. So it just seems a $130 million to $140 million is significantly conservative just in the very near-term or am I missing something?"
"You know, I don’t -- I really don't think you're missing anything."
Kulbinder Garcha – Credit Suisse
"I don't. I think, obviously we had an operational execution issue last quarter, in regards to the shortage. And so those are risks that we need to manage there. As regards to them being almost by the way, those are absolutely confirmed sales. So they're not almost solid. Those are sales that have shipped in the interim period."
Kulbinder Garcha – Credit Suisse
"Okay. And they…"
"Let's say we're off to a good start this quarter."
Take from that what you will, but I'm betting revenue in the next quarter comes in fairly high. OCZ has been a bumpy road, but I see light at the end of the tunnel.
shamapant owns shares of OCZ Technology Group. The Motley Fool owns shares of Microsoft. Motley Fool newsletter services recommend Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.