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Should You Buy, Sell, or Hold Fusion-io?

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Every now and then, an interesting company comes along with a truly innovative technology that has the potential to disrupt incumbents and rake in profits in the process. Solid-state drive (SSD) specialist Fusion-io (NYSE: FIO  ) went public last year and has quickly gathered the tech world's attention with its technology, involvement of Apple co-founder Steve Wozniak, and drool-worthy growth. The company also boasts Facebook as one of its biggest data center customers.

Should you buy, sell, or hold Fusion-io?

Buy: disruptive potential
Fusion-io implements solid state differently from traditional data providers. By moving data closer to where it's processed with a process it calls data decentralization, Fusion-io crushes latency and jacks up performance and data-center efficiency.

To be clear, Fusion-io's technology isn't revolutionary, as it doesn't address some underlying issues with flash technology itself, like the inevitable degradation of the chips over time. A recent research paper actually detailed a "bleak" future for SSDs, because of the inevitable trade-off between performance and capacity. Increasing capacity by cramming more data into each cell also increases error rates. The research is based on existing technology and doesn't incorporate specialized flash controllers like Fusion-io, OCZ Technology, or Intel (Nasdaq: INTC  ) use, so hopefully future innovation will address the concerns the paper brought up.

That being said, Fusion-io still has disruptive potential with its unique implementation of flash technology and could very well signal the evolution of where SSDs are headed, particularly in the lucrative enterprise market.

Buy: promising growth
So far, Fusion-io's technology has translated into healthy top-line growth, soaring 169% last quarter to $84.1 million, although a downtick in margins caused a mean sell-off. That resulted in a GAAP net loss of $0.07 per share, but the company has been able to squeeze out profits before.

Fusion-io Revenues Chart

Fusion-io Revenues Chart by YCharts

The company had just $10.1 million in annual revenue as recently in 2009 and now boasts $297 million in revenue on a TTM basis. If it can keep marching its top line higher, then profitability should take care of itself shortly thereafter.

Sell: valuation
Fusion-io is a pricey stock, any way you slice it. Shares are trading at 160 times earnings, 8 times sales, and 186 times free cash flow. Those are some nosebleed multiples that show that investors are already looking for major growth potential ahead. If Fusion-io stumbles or its growth prospects come into doubt, there's a long way to fall.

This is particularly a concern given that Fusion-io's technology is so innovative, as that will simply attract rivals, some of which are much larger and very capable contenders. EMC (NYSE: EMC  ) just unveiled its VFCache offering, which is a direct competitor to Fusion-io's storage architecture. The announcement validated the smaller company's approach but also shows that competition is heating up.

There is commoditization risk as competitors invade, which can hurt pricing power, gross margins, and growth prospects.

Sell: limited patent protection
Having innovative technology doesn't do you any good if you can't protect your innovations, and Fusion-io doesn't have much defense here. In its most recent 10-Q filing, the company concedes that its IP provides "only limited protection." As of this month, it has only 13 issued patents and 97 patent applications within the U.S. and just as many in foreign countries.

Fusion-io's growth is attracting attention, and if rivals are able to replicate its value proposition, the company will be left with nothing but a sob story.

Hold: potential acquisition
As a small innovator, Fusion-io is the frequent subject for takeover talk. Just last week, there was dubious speculation that Intel may be interested in the company to incorporate into its own enterprise SSD offerings. On the other hand, Intel is more likely to push for commoditization within the niche that Fusion-io plays in to bolster server unit demand, so it wouldn't make sense that Chipzilla would want in on the associated margin compression.

Beyond Intel, there are still larger rivals that could some day try to pick up Fusion-io. Acquisitive EMC is clearly interested in the technology, but its VFCache introduction means it will try to compete directly instead of buy in. If VFCache doesn't stand up to Fusion-io, EMC could potentially make a move, but that would be further down the road. Storage player NetApp (Nasdaq: NTAP  ) could even be a potential suitor as a way to tap into enterprise SSD, instead of developing a similar offering like EMC did.

Someone may yet acquire Fusion-io some day, but I would never recommend buying shares on acquisition speculation. It's a juicy possibility, but not one to bank on.

The verdict
With the understanding that Fusion-io shares carry their fair share of risk, I think it's a buy. The company has pioneered a unique approach to SSD architecture that has promising prospects within the growing enterprise data storage market, and the benefits of data decentralization are showing in the company's top-line growth.

The risks are also stacked up, as Fusion-io trades at lofty multiples and competitors gear up, but I think the potential explosive rewards are commensurate with the dangers. An acquisition would be a nice surprise, but hardly worth counting on.

I've already given Fusion-io an outperform CAPScall since I think it will be a winner in the long term. It's not for the faint of heart, but this potential disruptor has my blessings.

As promising as Fusion-io is, it's not The Motley Fool's Top Stock of 2012. That title goes to an exciting company that's tapping into retail growth in emerging markets, whose business model resembles two retail household names that you likely shop at each week. Get access to the free report now.

Fool contributor Evan Niu owns shares of Apple, but he holds no other position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of EMC, Apple, Western Digital, and Intel. Motley Fool newsletter services have recommended buying shares of Intel and Apple and creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 24, 2012, at 12:32 PM, hadleycap wrote:

    With all due respect your analysis is missing the point. The solution which Fusion is leading is radical. Has flash been around a long time.... yes. it's the solution, the software layer. Disk Drives are 50 year old technology and they can not be optimized in the cloud... Why is Facebook built on FIO? Why are APPLand CRM buying like crazy? Here's another way to think about this. When Woz and Jobs built Apple... micro processors had been around much like flash. You could argue the product apple built and assembled wasn't really radical but it certainly became so.

    Flash is only going to improve... software is only going to improve and the cloud will demand faster solutions where all kinds of stored bits will need to move as fast as the processors.... that isn't going to happen with HDD's. The question we need to ask is this... Will Fusion win this game? The market for this solution is huge. Apple IOS and Google Android are the front of the food chain... All those mobile devices will be pushing and pulling real time bits into and out of the cloud (brain). it's going to have to move fast... Ask Apple how they are using fusion-io with SIRI... it's all about the solution.

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