Datalink: Lesser Known, Lower Risk Data Storage Stock Exhibiting Strong Growth

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Manish Babla submits:

Two weeks ago, on January 18, Datalink ( DTLK ) released outstanding guidance for the December 2010 quarter, projecting $90 million in revenue and $0.21-0.24 per share in 'pro forma' earnings.

This is a strong acceleration in operating performance over recent quarters (see the table below), and also a significant improvement over the company's own projections issued just 3 months ago of $75-80 million revenue and $0.12-0.16 pro forma earnings.

Quarter Ending

Mar

2009

June

2009

Sep

2009

Dec

2009

Mar

2010

June

2010

Sep

2010

Dec

2010

Revenue (in $ million)

39.9

43.7

42.7

51.8

62.5

70.9

69.2

90

Pro forma Earnings

(0.02)

0.05

0.03

0.10

0.01

0.06

0.11

0.21-0.24

On the day following the earnings guidance, the stock closed above $6 (up from the $4.50s) prior to the news, and it is currently trading in the $6.50s. However, as explained below, the stock offers a far better opportunity to play the ongoing explosion in data storage and virtualization needs than the more popular growth 'names' such as F5 Networks ( FFIV ), VMware ( VMW ) and Netapp ( NTAP ).

Also, for investors having a modicum of appetite for risk, the stock offers the opportunity for 'sizable' gains over the next 3 to 6 months, based on both its current operating performance and the projected explosion in enterprise data storage needs going forward.

Company Background

DTLK provides data center solutions to Fortune 500 and mid-tier enterprises, helping them consolidate data storage on-site, migrate it off-site to virtual data centers, ensure data protection, and plan for business continuity and disaster recovery. They were established in 1983 and are headquartered just outside of Minneapolis, with over 300 employees staffed in 32 cities nationwide.

The company has an active acquisition strategy, targeting selective acquisitions of profitable companies in the $30-50 million revenue range that either provide complementary data center expertise, add customers, or expand their geographic reach. Their recent year-to-date (ending September 2010 quarter) revenue growth of 60% included 24% 'organic' growth and the rest through two recent acquisitions. This includes the October 2009 acquisition of Cross Telecom for $2 million, which helped them fill a key skill set in their expansion into the data virtualization solutions market, and the December 2009 acquisition of reseller Integra, LLC, for $8.8 million, which added $80 million to their revenue and over 2,000 enterprise customers to their target list for data center solutions and services.

It appears from recent quarterly reports that the acquisitions may be bearing fruit in the form of accelerated revenue growth, albeit at lower gross margins due to the reseller business of Integra. Also, with the increasing breadth of product offerings, DTLK is closing larger contracts as it did in the August 2010 quarter when it was awarded its largest contract to date worth $8 million for a virtualization and consolidation project by a leading global consulting and software company.

Their business growth is driven by several major technology trends, including:

  1. Increase in data storage needs associated with the 'mobile tsunami', medical data storage needs, etc.;
  2. Increasing demand for server virtualization to optimize IT assets, a market that Gartner estimates is growing at a 30% annual 'clip'; and
  3. OEM's increasing their use of indirect sales approaches to deliver their products at higher margins, and increasingly turning to solutions providers such as DTLK to sell their products.

Valuation

Based on the observed acceleration in revenues and earnings so far - including the 21-24c quarterly earnings projected for the December quarter and the company's own optimistic assessment of continued strong demand - the stock is trading at a discount to both its own historical financial ratios and as compared to peers operating in the data storage solutions and virtualization space.

Historically, DTLK shares have generally traded in a 10-30+ forward PE trading range (based on pro forma earnings) going all the way back to 2005 (see the table below).

Fundamentals for Fiscal Year ((FY))

FY2005

FY2006

FY2007

FY2008

FY2009

FY2010

Annual Revenue (in $ million)

117

146

178

196

178

293

Annual Earnings (Pro forma)

0.06

0.36

0.21

0.36

0.16

0.39

Trading Range During FY

$1.85-

$4.42

3.80-

12.50

3.55-

9.57

2.16-

6.45

2.45-

4.60

2.93-

5.00

General Forward PE Range

10-25

15-40

15-35

10-25

10-20

8-12

Based on the company's projected acceleration to $90 million revenue and 21-24c earnings for December 2010 quarter and improved numbers going forward, a $12 minimum target was calculated based on a conservative PE ratio of 15. The $12 target also equals the prior recent high of $12.50 set in October 2006 when DTLK generated only $30 million and $0.12 per quarter, so based on that the $12 target seems quite achievable. Also, the $12 target compares quite well to the $6.50s high set in July 2008, when DTLK generated 50% lower quarterly revenues and earnings at $45 million and $0.10 respectively than what it is generating today.

Please note that DTLK currently has coverage by only 1-2 analysts, and since their estimates were so far off-the-mark for the December 2010 quarter, and since 2011 estimates have so far not been revised, projections based on the company's own guidance and general statements were used in preference to analyst estimates for FY 2011.

DTLK competitors include large enterprises such as International Business Machines ( IBM ), Oracle Corp (ORCL), Hewlett-Packard (HPQ) and EMC (EMC), all of which are growing much slower near 10% and are trading at between 10-15+ forward PE. Also, data storage and virtualization hardware and software vendors such as VMware ( VMW ), Netapp ( NTAP ), Citrix Systems (CTXS), Riverbed Technology (RVBD), and F5 Networks ( FFIV ) that are growing at 20%-40% are trading at much higher forward PE's of 25-40, so the minimum target of $12+ for DTLK based on a forward PE of 15 appears reasonable.

Further, DTLK also has a strong balance sheet with $17 million in cash and cash equivalents, and no debt.

Recent Price Action in Sector

Although DTLK share prices gapped up following the December 2010 guidance on January 18, they have since consolidated for the last two weeks in the $6-7 range. This has happened at a time of general weakness in the entire data storage and virtualization 'space.' Specifically, on January 19, cloud computing momentum 'darling' FFIV reported a less than 'stellar' quarterly report (see conference call transcript here ) that sent the entire cloud computing and associated network data storage sector collapsing, including also NTAP and VMW by an average of 10%-20%. Specifically, VMW gave back $5 billion of its $40 billion market capitalization in just 4 days.

This 'story' has been repeated many times before, including most recently when network data center services provider Equinix (EQIX) warned in early October of last year, and all of the above mentioned 'cloud computing' stocks corrected between 10%-20% and later in the next month or two were back up above their previous highs and going higher. This happened as it became clear once again that one company's mis-step or less than 'stellar' performance does not spell 'doom' for the entire sector. It is possible that we are in a similar period today and as these 'leaders' consolidate back up and higher, it may propel DTLK even higher.

And even if the FFIV news spells the end of the run-up in data center stocks going forward, which appears unlikely as both data storage and virtualization appear to be multi-year trends and we may only be in the fourth or fifth innings, an investment in DTLK will fare much better in that environment as the low valuation gives it a lot of 'downside' protection compared to the lofty valuations of sector leaders in the 25-40 forward PE range.

Conclusion

DTLK shares are trading at a steep discount to fair valuation based on a comparison to both its own historical ratios as well as those of its nearest peers. A minimum target of $12 is achievable in the medium-term, in the next 3-6 months, which is almost double compared to current prices. The stock has been consolidating between $6 and $7 over the last two weeks following the guidance on January 18, and looks set to break out and resume its march towards double digits.

This is based on the observed acceleration in revenue and earnings in the latest December 2010 guidance, the fact that it is trading at a steep discount both to its own historical ratios as well as compared to 'peers' in the 'virtualization' space, the projected explosion in enterprise data storage and virtualization needs, and an improvement in the US and global economies that will most likely lead to increasing enterprise IT budgets.

Lastly, while there is no guarantee that the economy will recover or that the company will continue to execute well, what is more 'certain' is that the demand for data storage and virtualization services will continue to explode and so will the potential demand for the company's services. What DTLK offers is an opportunity for a 'cloud computing' / data storage investor to diversify out of well-known momentum names such as NTAP and VMW that are trading at huge valuation premiums into a lesser known, lower risk data storage solutions company that is also exhibiting strong growth but trading at a huge discount to the overall sector (not even factoring in the growth rate).

The company is scheduled to release its December 2010 quarter and guidance for the current March 2011 quarter (as it always does in its quarterly reports) on February 17, 2011.

Disclosure: I am long DTLK

See also Investing In the Oil Sands: 4 Stocks on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: DTLK , FFIV , IBM , NTAP , VMW

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