Dueling Fools

Dueling Fools

Bear Argument

By Paul Larson (TMF Parlay)
November 24, 1999

It's D�j� vu all over again. This Duel isn't the first where I've written the bearish case against Iomega. And like last time -- back in early 1998 where I only got 28% of the vote -- I suspect my opinions will not be much more popular to the Foolish community this time around. Nevertheless, I have every reason to believe that the company and the stock will continue to head the same direction it has over the past two years -- down.

When thinking about where Iomega is as a company today, consider the following:

  • Iomega has seen six straight quarters where revenue was lower than the same quarter in the previous year. Forget about growth; Iomega is a contracting organization.

  • The company lost over $54 million in 1998 ($0.20 per share), and over $105 million in losses ($0.40 per share) are expected this year.

  • Even after dominating its market through much of 1996 and 1997, the company's retained earnings (the cumulative profits and losses of the firm since inception), is now a mere $2.9 million. In short, Iomega has failed miserably at creating value.

  • Iomega has burned through two permanent CEOs over the past two years. No fewer than four different people have held the CEO post since early 1998, and the hunt for #5 is ongoing.
Do these facts instill confidence in the company, or do they make you think twice about the quality of the organization? For me, it's certainly the latter.

But that was the past, and the years to come are what we should really care about. Let's look at each of Iomega's four product lines and where they are positioned for the future.

I think the scariest thing for Iomega is the fact that Zip was first introduced back in 1995. In the hyper-changing world of computers, to say the product is getting long in the tooth is an understatement. Sales of the product have essentially been flat over the past year, and I think it will be sooner rather than later before the product and its sales fall down the inevitable tail-end of the life cycle.

My thinking is that the same reasons Zip never became ubiquitous will accelerate the product's maturing process. The two primary uses for Zip -- moving files and backup -- are becoming easier and cheaper to do with competing technologies. Why physically move files when you can just send them electronically? Plus, hard drives and other forms of fixed storage continue to get larger and cheaper.

I would even argue that in today's networked computing environment, there is no need for removable storage at all. One only has to look as far as the popular Apple (Nasdaq: APPL) iMacs to see a real-world example of a computer line sans removable storage. Why buy a removable storage company when the industry as a whole has an uncertain future?

The company has said that Jaz is a maturing product line and not to expect much in the way of sales or profits from the product in the future. The company has cut R&D spending on newer versions of the Jaz, and I think that's a troubling fact. While slashing R&D may improve profitability in the near term, it makes it much more difficult to produce winning products in the years to come.

ZipCD marks Iomega's foray into a field where the company does not have patents or proprietary technology to hide behind. Instead of competing with a handful of competitors, Iomega is going up against literally dozens of companies in the field, including such technology titans as Hewlett-Packard (NYSE: HWP) and Sony (NYSE: SNE). Plus, Iomega's much touted "razors and blades" business model doesn't work with ZipCD since recordable CDs are a commodity.

Many of the Iomega bulls seem to hope that the miniature Clik! drive will be the company's salvation. While it is an interesting little product, the initial numbers are anything but encouraging. Clik! started shipping in limited quantities roughly a year ago, and in the most recent quarter Clik! brought the company a mere $6 million in sales. This product line also brought Iomega $20 million in losses last quarter before a restructuring charge and $31 million in losses after the charge.

Even if one assumes that Clik! is still in its start-up phase, I think the product is going to be faced with some profit difficulties going forward. Just like Zip saw much of its growth undermined by the prices of hard drives taking continual nosedives, Clik! will be forced to compete on the price-performance curve of flash memory. And since memory prices have historically proven to be extremely volatile and among the most likely to decrease rapidly, it's not a battle I would want to wage.

Lastly, I think it's worth pointing out that Iomega's executive offices seem to have revolving doors installed as standard equipment. Not only has the company burned through several CEOs over the past two years, but numerous other top executive positions are also vacant or are filled on an interim basis. Needless to say, this is not exactly a sign of a vibrantly growing organization. The company needs strong leadership to make it through the tough times, and it is something that is sorely lacking right now. Moreover, it will be tough to attract talent to the company given its questionable strategic positioning and its anemic finances.

Forget about attracting talent; Iomega is going to have a difficult time attracting investors down the road unless something drastic happens.

Next: The Bull Responds