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Is STEC Stuck in Reverse?

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Wall Street can't generate enthusiasm for solid-state drive maker STEC (Nasdaq: STEC  ) , so why do our Motley Fool CAPS members disagree? More than 730 members of the investment community have weighed in on its prospects, and 92% of them see it outperforming the broad market averages, bestowing on it high honors with a four-star rating. In contrast, 44% of the analysts rating it believe it will stumble.

So who has it right? The professional class of analysts sitting in their paneled offices smoking stogies, or a motley community of investors pooling their best thoughts for others to share? We think we know who'll come out ahead. How about you?

STEC Snapshot

Market Cap $332 million
Revenues, TTM $222 million
1-Year Stock Return (25.8%)
Return on Investment (18.9%)
Estimated 5-Year EPS Growth 25.3%
Dividend and Yield NA/NA
Recent Price $7.13
CAPS Rating (out of 5) ****


Of course, as much as we love our CAPS community, don't buy a company just because it's garnered top ratings. And don't sell it just because Wall Street says to, either. Investing requires closer diligence on your part, so use a stock's CAPS rating as a launching pad for your own research.

Take it for a spin
The disk-drive maker is in the midst of a transition that may take some time to gain traction, but the 50% drop in revenues STEC experienced last quarter must have investors wondering how long it can survive. The rate of decline is accelerating each quarter, and losses are growing wider, too. Still, the switch from a manufacturer marketing its drives through OEMs to one selling directly to enterprise customers and end-users suggests it's having a tough time in the marketplace against rivals OCZ Technology (NYSE: OCZ  ) , Western Digital, and SanDisk (Nasdaq: SNDK  ) .

Almost 90% of its revenues come from its top 10 customers, while the top three -- EMC (NYSE: EMC  ) , IBM, and Hitachi -- account for 70%. So STEC's rationale for the marketing shift is to break the stranglehold of customer concentration, but in the meantime, it has to wait for OEMs to qualify its new products, and that's taking an inordinately long time to accomplish. So it's still relying upon its big customers for the bulk of its business (they added up to 85% of revenues in the second quarter) while adding in a few new ones here and there.

An Olympic challenge
STEC says the worm will turn in the fourth quarter, when OEM qualifications are completed, but the bulk of its revenues come from its older ZeusIOPS technology, and its customers are looking for new SAS interfaces or fiber channel-based SSDs. Its competitors have already had their products qualified at some of STEC's customers, and that's leading to fewer ZeusIOPS sales.

So why are its OEMs taking so long to qualify its products? Well, STEC identifies a handful of them, including switching from one NAND supplier to another whose flash memory acts differently from the original one, moving to a smaller 30 nanometer form factor, and changing from single-level cell to multilevel cell technology that provides greater memory capacity at lower cost.

The sandman cometh
With losses as far as the eye can see, STEC is trading well behind OCZ, WD, and Seagate Technology (NYSE: STX  ) , all three of which have not-so-arguably better prospects ahead of them. While the insider-trading charges against its CEO will ultimately be resolved without too much tumult at the company, its auditor, PriceWaterhouseCoopers, just resigned, and analysts say it might not want to be tarnished by the taint of scandal.

There's been a lot of dust kicked up around STEC, making it difficult to clearly see the road it's traveling, but it's clear even management doesn't see a turn coming until the fourth quarter -- and then it has a long road to hoe to catch up to rivals already racing ahead. I've rated STEC to underperform the markets on Motley Fool CAPS, but let me know in the comments section below if you think it will still make a solid investment.

What's wrong with that?
STEC dominated the solid-state drive market at one time but chose to rest on its laurels while rivals innovated. The Motley Fool has identified three promising stocks that find themselves in the same position of dominating their markets, and you can learn all about them in the Fool's special report, "3 American Companies Set to Dominate the World." Get your free copy today to see why they won't make the same mistakes.

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

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