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Published: September 10, 2010
With economic growth
potentially stagnating, large firms are resorting to buying
market share by acquiring rivals or know-how that will help
them grow fast and stay one step ahead of the competition. M&A
activity in the cash-rich technology industry has grown
especially rampant as of late. For example, two giant tech
firms, Dell (Nasdaq: DELL) and HP (NYSE: HPQ)
feverishly competed to acquire data storage server firm 3PAR
(NYSE: PAR).
3PAR has jumped more than three times since the original bid was
placed in mid-August and illustrates that the data storage
server market is highly appealing. [See:
This Company's 10-Day, +169% Run is Heating up an Entire Sector]
Firms and individuals have growing needs for storing and
retrieving the massive amounts of electronic data being created
these days, be it email, online customer tracking and
management, or file backup, just to name a few.
Now, it looks like HP won the bidding for 3PAR, but a small firm
that could easily be put into play is Xyratex Ltd. (Nasdaq:
XRTX). The stock is incredibly cheap right now -- valued at
a laughable
earnings multiple of five -- and would make an easy target
for Dell, or a similar competitor.
Xyratex began as part of tech titan IBM (NYSE: IBM) in
1966 but was separated in a management
buyout in 1994 and went public at that time. The corporate
strategy has evolved over time and currently consists of
providing high-end data storage products for hardware and disk
drive manufacturers.
More specifically, Xyratex's primary division sells hard disk
drive storage subsystems to the likes of NetApp (Nasdaq: NTAP),
Dell, IBM, and Seagate (NYSE: STX). NetApp is the biggest
customer, at 48% of last year's revenue and was followed by Dell
at 15%. Xyratex also sells storage infrastructure products that
clients use to produce disk drives. Its products have been
involved in the cleaning and testing of 75% of all hard disk
drives globally.
Sales fell in the double digits
last year due to the economic downturn and loss of some business
from NetApp, but have still averaged more than +13% growth
annually for the last five years and have demonstrated a steady
upward trend for about a decade now. Profitability tends to
fluctuate along with the industry, which despite strong growth
tailwinds, remains cyclical. Fortunately, recent trends are on
the upswing as analysts project more than $4 in earnings for
2010.
Expectations are for profit improvements to slow from this
breakneck pace and dip below $3 per share for the coming year,
which a colleague of mine attributes to a higher tax rate as tax
credits from past losses run out. At these profit targets, a
recent share price of $13 represents a very low earnings
multiple of five. Again, profits fluctuate, but Xyratex has been
free cash flow positive every year this decade and is
debt-free, which makes the shares such a compelling deal.
Xyratex currently sports a
market capitalization of $355 million. This places it firmly
in small-cap territory and indicates two things. First, growth
is easier given the small installed sales base it has to grow
from. Secondly, a suitor could acquire it rather easily and for
all cash, given the billions of dollars many larger tech firms
are holding on their balance sheets. The bargain-basement
valuation further supports the buyout argument.
Action to Take --> Xyratex's
fortunes are clearly linked to NetApp, which is a good thing
given NetApp has been growing rapidly along with the storage
industry. Aside from Dell, NetApp could also be a potential
suitor, especially if it wants to push Xyratex's products out of
competitors' hands. Really, any of its major clients are fair
game on the M&A front.
Bids for 3PAR demonstrate the potential upside of a buyout.
Additionally, improving operating fundamentals support a
P/E multiple closer to overall stock market levels in the
mid-teens and suggests that a three-fold increase in the share
price could be a conservative target.
-- Ryan Fuhrmann
Contributor
StreetAuthority
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