STEC, Inc.: Solid state disk drive maker's risky bet pays off
As memory chips keep increasing in capacity, “solid state” devices with no moving parts relentlessly displace storage devices that depend on spinning disks. Just look what Apple’s iPod has done to portable CD players.
Now STEC, Inc. (Nasdaq:STEC), formerly known as SimpleTech Inc., based in Santa Ana, Calif., has made a bold move into solid state drives (SSDs) made from “flash” memory chips that can similarly replace hard disk drives (HDDs) on computers. Founded in 1990, and public since October 2000, SimpleTech has made a variety of memory products — such as memory boards, plug-in flash drives and plug-in SDDs — for both consumers and corporate systems, including Cisco (Nasdaq:CSCO) routers. But technical issues and costs have largely kept SDDs relegated to a niche of add-on storage devices rather than as full-blown replacements for HDDs.
So in February 2007, SimpleTech got serious. It sold its consumer business to privately held Fabrik Inc. for $43 million and changed its name to STEC, Inc. It also began developing a new line of high-capacity SSDs for EMC Corp. (NYSE:EMC), a leading provider of corporate storage, backup, and security products and services.
Investors didn’t get it, though. Between Jan. 3 and May 21 of 2007, the stock plunged to $5.80 from $12.92. It bottomed at $5.67 in early March 2008, after STEC announced a fourth-quarter profit of $1.4 million, down 85% on revenues that were down 28.7% to $53 million because of the missing consumer business.
But it’s now payoff time. On Jan. 14 of this year, STEC announced that EMC would begin incorporating its 73-gigabyte and 146-gigabyte ZEUS IOPS SSDs in some of its high-end networked storage systems. Corporations that conduct hundreds or even thousands of transactions every minute, such as investment and credit card companies, need ultra-fast storage and retrieval systems no matter what the cost; EMC began providing them.
The EMC deal “gave people in the industry a wakeup call that (SSD technology) is fully baked,” says Richard Kugele at Needham & Co. “EMC would never use something that wasn’t.” Kugele initiated coverage of STEC with a “buy” rating on March 10.
On May 5, STEC announced its first-quarter earnings. It earned $2.1 million, or $0.04 per share, down from a profit of $6.7 million, or $0.13 per share, in the same period a year earlier. But last year’s results were boosted by a gain of nearly $8 million from the sale of the consumer business to Fabrik. Revenues were up 7% to $50.7 million, including $7 million in revenues from the ZEUS IPOS systems, which only went on sale in the last month of the quarter. Street consensus was for earnings of $0.03 per share on revenues of $46.2 million.
Even better was the guidance for the second quarter: revenues of $52 million to $54 million, and pro forma EPS of $0.07 to $0.08, beating Street estimates of $50.8 million and $0.06 per share. STEC also held an analyst event on May 14 to explain its strategy and outline the advantages of its SSDs to analysts. Kugele has been impressed enough to raise his target twice price, to $18 on May 15 from $8.50 on March 10. Richard Shannon at Northland Securities has an “outperform” rating with a price target of $14.
Investors keep raising their prices, too. The stock reached an all-time high of $13.50 on May 19 and closed at $12.39 on Wednesday. It has a market cap of $610 million.
So far, EMC is the only customer for STEC’s high-capacity SSDs; its agreement prohibits STEC from selling to anyone else before the end of the September quarter.
STEC also announced plans for one-inch SDDs ranging from four megabytes to 32 megabytes targeted at Ultra-Mobile PCs, although Kugele thinks high costs will keep that market limited for now. Still, industry rumors say that Apple (Nasdaq:AAPL) will introduce Ultra-Mobiles with SSDs from Samsung late this year.
But the real opportunity is clearly the high-end SSDs. IBM (NYSE:IBM) and Hitachi Data Systems have announced plans to tackle the high-end SSD market, but STEC is at least a year ahead of them.
Seagate Technology (NYSE:STX), the leading HDD maker, responded in a different way. On April 15, it filed a patent infringement case against STEC for certain technologies used in SSDs, but the case is widely viewed as a delaying tactic with little chance of success. One of the allegedly infringing technologies is “stacking technology.” STEC was sued over that one years ago and managed to successfully defend itself all the way to the Supreme Court. “It’s really kind of silly,” says Kugele.
That makes Seagate’s suit look like a desperation move. “Seagate makes 80% of its money on the 5% of its sales that go to the enterprise market,” says Richard Shannon at Northland Securities. “That business is going to disappear in two years.”
There’s another potential solution. Seagate could just buy STEC. Both analysts expect some savvy HDD maker to do so soon. The question is, at what price. STEC was founded by three brothers who own a controlling share of the stock, and they’re likely to hold out. They’ve already had four offers.
Shannon thinks Seagate should just buy the company now rather than waiting for the price to rise — the stock has already risen 84% since the suit was filed. “Seagate should just offer $30,” says Shannon. “It would be stupid for them to not just say, ‘What's your price?’”
But even without a buyout, STEC looks promising, as its technology is not easy to duplicate. Most important is its critical controller technology that keeps cells from dying too quickly from overuse, a problem with flash chips (Seagate did not sue over the controller technology).
About the Author
Richard L. Brandt is a journalist and author with more than 20 years' experience covering science, technology and business.
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