There tend to be two types of investments in the computer storage world. On one side of the fence, there are names that have real, sustainable competitive advantages that generally drive those businesses into a very lucrative duopoly/oligopoly. Think names like Micron (NASDAQ:MU), SanDisk, Western Digital, and Seagate. The former two are making a killing riding the secular growth of NAND flash, while the latter two are raking in the dough with their hard disk drive duopoly (OK, Toshiba still technically makes hard drives, too).
Unfortunately, along with these money-printing machines, investors also see the story – stock high fliers that, despite having some neat-sounding technology and hyper revenue growth rates, ultimately end up with businesses that simply can't scale to profitability – often times due to the fact that the value on top of commodity hardware simply isn't there. While there are many such names, none is more tragic than the story of OCZ Technology Group (NASDAQ:OCZ).
OCZ: Going from bad to worse
OCZ started out as a reseller of commodity DRAM to PC gamers, but as this business failed to become profitable, the company switched to developing solid state flash drives for PCs. While OCZ took a number of steps to differentiate itself, most notably by purchasing Indilinx, a developer of NAND flash controllers for such drives, as well as picking up some enterprise storage software assets in a bid to be a meaningful player in the higher margin enterprise flash markets, it was all in vain. The company never managed to post a profitable year.
But, things got worse during late 2012. After several quarters of very poor financial performance, CEO and founder, Ryan Petersen, resigned abruptly. Shortly thereafter, it was revealed that OCZ's financial statements had several glaring errors that ultimately led to an SEC investigation and a year-long effort to restate financials all the way back to 2009. After several delays and missed deadlines, OCZ finally filed its restated financials – ugly as they were.
The company burned through many secondary offerings' worth of cash (totaling several hundred million dollars), has taken loans on very unfavorable terms, and desperately cleared out inventory at significant losses to maintain liquidity. The financial situation today isn't all that great, despite the fact that the books are finally clean. OCZ is still a mess, and even at $1.22 per share, the likelihood that the shares trade much lower is very real.
There's little hope left for OCZ as a stand-alone business
A major problem of OCZ's was that it attempted to sell commodity solid state drives in a market in which the NAND flash manufacturers hold all the cards (and the profits). While these low-end commodity businesses are largely done at OCZ, the company is still trying to play in the enterprise flash space. The problem here is that, even though NAND flash supply isn't everything, the competitive environment is incredibly fierce. Even players such as Fusion-io and the recently public Violin Memory, with well-known customers and fairly differentiated technology, still have a rough time breaking even, let alone turning a profit. sTec, another pure-play fabless enterprise flash player, was also bleeding money before it was finally acquired by Western Digital on the cheap.
So, owning OCZ today is really a bet that one of the larger players may be interested in acquiring the company. And, quite frankly, OCZ doesn't really have much to offer a larger player at this point. The only valuable IP it has is the SATA SSD controller from Indilinx, but with LSI and Marvell offering excellent controllers at a fairly low cost, and with many of the NAND flash players having already bought controller IP, it's tough to see a lot of value here.
The Foolish bottom line
If you want to invest in the storage industry, it is much better to pick high-quality names with sustainable advantages than to pick a company that's facing significant liquidity issues, offers no real competitive advantages in a highly competitive market, and just spent the last year without up-to-date financials. For OCZ, the risk/reward, even at a tempting $1.22 per share, just doesn't look good enough for even the most risk-tolerant long-term investor.
Ashraf Eassa has no position in any stocks mentioned. The Motley Fool owns shares of Western Digital.. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.