OCZ Technology Group (NASDAQ: OCZ ) is – soon to be "was" – a fabless vendor of solid state flash drives for both enterprise and consumer applications. While the company had originally had aspirations to be one of the leading solid state disk drive vendors, that's not how things played out. After burning through hundreds of millions of dollars, and after a year spent in a bid to restate its financials, OCZ bit the bankruptcy bullet and sold its assets to Toshiba for $35 million. The company is finished and the stock now worthless, but that doesn't mean that there aren't better ways to invest in this space.
Why did OCZ die?
In order to invest in this space it's important to understand just what went so terribly wrong. The biggest part of the bill of materials for a solid state drive (according to Marvell (NASDAQ: MRVL ) at the Credit Suisse Technology Conference, roughly 95% of a solid state drive's value comes from the NAND flash – although this will certainly vary based on drive size) is the NAND flash. This means that the heavyweights that have their own flash factories – think Samsung and Micron (NASDAQ: MU ) – are the best positioned to benefit from the massive growth in flash.
Indeed, a player that lacks the ability to manufacture NAND flash has to pay the flash maker's margins and then, after that, needs to add enough value (through performance, reliability, brand, and the like) to justify a meaningful premium over the bill of materials cost. Unfortunately, while fabless firms like privately traded Corsair Components have driven profitability through specialization in high-value niches (in Corsair's case, it leverages its brand as a PC gaming component maker to drive sales of high performance drives), OCZ tried to attack the broad swath of the market – and it failed.
OCZ, at first, seemed to be doing well as its gross margins seemed to be on a nice uptrend. While operational expenses continued to climb right along with revenues, what wasn't revealed until much later is that the gross margin expansion was a mirage, hidden in operational expenses through aggressive rebate programs. When this was discovered, the company was forced to restate its financials. A year after the restatement efforts began, the company's books were finally clean – just in time for the company's bankruptcy (since the company's business model was simply unsustainable and it had burned through its cash reserves).
Where to invest, then?
There are two interesting ways to play the secular expansion of the flash market. The obvious way would be to buy Micron (Samsung is a good play, too, but the shares are exceptionally difficult for US-based investors to get a hold of) – it's a leader in DRAM and NAND flash, both essential components in just about every modern computing device today. The company's shares are on fire, having quadrupled from its 2011 lows, but on a pullback the shares could be very interesting.
A less obvious way would be to try to play it from a chip perspective. While many SSD vendors have internal SSD controllers today, as Marvell pointed out at the Credit Suisse Technology Conference, the controller is such an insignificant part of the bill-of-materials that if a merchant chip vendor can do a better job (that is, develop a controller that is faster and extends the lifespan of the NAND flash) than what the internal controller trams can do, then the flash vendors will likely very happily switch to merchant chips.
This means that both Marvell and LSI (NASDAQ: LSI ) are interesting ways to play this space. Now, both of these names are actually pretty diversified – and fairly overlapping names. Both participate in storage controllers, but Marvell also has exposure to mobile processors (and connectivity) while LSI seems to have a much more aggressive network and communications infrastructure as well as PCI-Express flash cache card strategy. At any rate, if the flash controller market eventually goes to a largely merchant-chip based industry (and according to Marvell again at the Credit Suisse Technology Conference it is), then these two players will enjoy a duopoly similar to the one seen today in hard disk drives.
Foolish bottom line
Just because one company with exposure to a high growth industry goes bust doesn't mean the whole industry is bad – it just means that particular company didn't have a good business model and/or the right management team to execute on that model. OCZ's business model was broken and the management team left to clean up the mess couldn't fix it before the cash ran out. But Micron, Marvell, and LSI all have viable, profitable business models and should – at the very least- be on the watch-lists of anybody interested in investing in flash.
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