I have said many times that, with some exceptions, I am not a fan of companies that have never made money. That is, after all, the most basic function of a corporation. I have been quite negative on Twitter (TWTR) for example for that reason. That doesn’t, however, mean that I would never consider a company that isn’t currently making money.
When a previously profitable enterprise swings to a loss there are some basic questions to be asked. Is the change specific to that company or does it reflect a downturn in the line of business? If the latter is the case, then is that downturn temporary or terminal? If it is a temporary downturn, is there a likely catalyst for improvement?
Following that line of questioning can often lead to a stock that is seriously undervalued based on current results and those of the recent past rather than possibilities for the future. The Nasdaq-listed Mellanox Technologies (MLNX) is just such a stock. Before you look, I should warn you that the 2 year chart is not a pretty sight.
I guess the best thing that can be said about that is that we seem to have found a bottom around $30. The actual low, achieved, if that is the right word, on May 16th is $30.61, and the stock closed yesterday at $31.61. If you are going to attempt to catch a falling knife, however, you’d better have a good reason.
There are several reasons to buy MLNX right now. From a big picture, overview perspective it could be that their time is coming, or rather coming again. Mellanox make high speed and powerful computer components. Back in 2012 when they made $2.54 per share, every company that depends on computers (i.e. every company period) was gearing up for speed. It could be that Mellanox were a bit ahead of their time.
Put simply, they were selling speeds beyond what was needed. As a result, revenues, particularly in the High Performance Computing (HPC) division, fell dramatically in 2013 when every quarter showed negative year on year growth. HPC fell from 80% of the company’s revenue to less than 50% today. In response, Mellanox have expanded in other markets such as storage, data centers and cloud. All of these have seen expanding revenues in the last month and are part of the story.
Those revenues combined now form a core and backstop, but in the traditional HPC division there is hope of a return to former glories. Much of the reduction was due to budget restraints from government enterprises and the worst of those cuts seem to be over. Add to that opportunities from Intel (INTC)’s new generation of server processor and expansion in the area looks much more likely than further decline.
On a level more specific to the stock than product lines, you can also make a case for buying MLNX at these levels. Look again at the above chart. It is another example of the tendency of markets to exaggerate both ways. Even at an EPS of $2.54 the stock’s high of $120.05 was overdone. When the correction came, it did so with a vengeance. Just as the stock was overpriced then it is underpriced now.
Q1 results released in April showed an increasing loss for sure, but were not as bad as analysts’ consensus estimates, indicating that things may be turning around. Guidance was adjusted a little lower, but not enough to justify the subsequent 20% drop in the stock. We learned earlier this year that upward market momentum can lead to a sharp correction, but many forget that downward momentum can also be overdone.
Buying MLNX is a bet on a turnaround story to some extent. You need faith, not just that the overall market for their products is set to improve, but also that management is capable of capitalizing on that improvement. They have done so in the past, so I see no reason why they won’t in the future. The officers and board didn’t become bad managers overnight.
If you add it all up it looks to me as if Mellanox has fought through some tough times, diversified and expanded their product line in the process, and is now placed to capitalize on an upturn. They have shown before that they can make money and will do so again. When they do, those looking with 20/20 hindsight will see the current share price as ridiculously cheap, just as they now see the $120 price of a couple of years ago as ridiculously expensive.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.