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 (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. (XRTX). The stock is incredibly cheap right now -- valued at a laughable earningsmultiple 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 managementbuyout 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 ofNetApp (NASDAQ:NTAP), Dell, IBM, and Seagate (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.
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
A graduate of the University of Wisconsin and the University of Texas, Ryan Fuhrmann, CFA, adheres to a value-based investing viewpoint that successful companies... Read more...