Infrastructure
Commentary
9/26/2003
02:05 PM
William Schaff
William Schaff
Commentary
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Taking Stock: Vixel's Transformation: So Far, So Good, But ...

There are signs Vixel's strategy is working, but issues remain

Company transformations are often cataclysmic, sometimes catastrophic, but rarely uninteresting. Numerous tech companies both large and small have had to transform themselves following the burst of the Great Technology Bubble as markets disappeared overnight.

Vixel, which has a market cap around $196 million, is a case in point. The company went public in the second half of 1999. After a successful IPO, the stock went into free fall the next two years. Vixel originally designed and manufactured storage area network switches, competing with Brocade Communications and McData, but also had other products. As troubles mounted, the company decided to change its strategy. Quarterly revenue declined from a high of $11.5 million in the second quarter of '99 to a low of $4.7 million in the fourth quarter of '01. The company instead focused on the semiconductors inside SAN switches and other equipment dealing with switching lots of data fast and efficiently. Vixel's chips are used in Hewlett-Packard's and Fujitsu's storage offerings.

One of the first customers for Vixel's chips was Network Appliance, which needed to increase the reliability of its network-attached storage. Vixel's chips are now part of Network Appliance's NAS storage offerings. HP is the company's largest customer, accounting for more than half of revenue during the last couple of quarters. In addition to existing customers, Vixel also has six unannounced customer wins, meaning it's been selected for a product, but the product has yet to be launched and isn't yet generating revenue for Vixel. I believe the current book of business and these additional wins should allow Vixel to double revenue in 12 months to approximately $12 million per quarter. This should finally let the company become cash-flow positive, a positive event, in my humble opinion.

Vixel isn't a company without risks. It continues to burn cash every quarter; it has 18 months left at the going cash-burn rate. This little problem will take care of itself if the company doubles revenue, but it's nonetheless a precarious situation. Vixel is contemplating issuing more shares to boost cash a bit. New chip launches might be postponed, resulting in temporary cash savings. Other risks are customer concentration, with HP comprising more than 50% of sales, and emerging competition. For now, Vixel is the only player in this market, but QLogic and Broadcom have shown some interest and both would be formidable rivals.

Vixel's stock has had a spectacular run this year, up 300% since Dec. 31 as of Sept. 24. It has benefited from the increased appetite for risk that investors have exhibited as they snapped up tech stocks. This has resulted in a rather lofty valuation of Vixel, currently trading at roughly eight times trailing 12 months revenue. While there are signs that Vixel's new strategy is working, significant issues remain. I suspect that its stock performance will be a good indicator of how speculative the market is, given that much hinges on the future, not the least of which is becoming cash-flow positive.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.


To discuss this column with other readers, please visit William Schaff's forum on the Listening Post.

To find out more about William Schaff, please visit his page on the Listening Post.

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