Is QLogic Corporation a Turnaround Play?

QLogic  (NASDAQ: QLGC  ) has been in a slump for several years, with low operating margins and decreasing quarterly revenue. Within the last year, the company has been trying to adapt by changing CEOs, cutting costs, and investing in new product lines that might finally bring revenue growth.

Similar changes in other networking companies have resulted in significant stock-price gains. Can QLogic follow in the footsteps of such peers as Brocade Communication Systems  (NASDAQ: BRCD  ) and Juniper Networks (NYSE: JNPR  ) , and is now a good time to buy QLogic stock?

Restructuring and changes in networking companies
Several companies in the networking sector have been undertaking major restructuring over the past year. This probably reflects both lingering inefficiencies in corporations that have seen better days, as well as the need to adapt to new trends such as cloud computing.

In particular, both Brocade and Juniperhave announced similar plans to cut costs, prune product lines, and focus its research and development on the most profitable markets. Both companies also brought on new CEOs to help them implement the announced changes. Since starting with the restructuring, Brocade's share price increased by almost 70%, and there are reasons to believe Juniper stock will also see significant increases.

QLogic is a smaller company than Brocade and Juniper, but it's competing in the same market and is exposed to many of the same pressures and trends. Can it adapt in the same effective way as the bigger guys?

Some background on QLogic
QLogic's main business is network adapters, but it has also branched out to switches, storage routers, and application-pecific integrated circuits, or ASICs. It doesn't sell to end-users directly, instead doing most of its business through big IT manufacturers such as IBM, Dell, and Cisco, who integrate QLogic's technology as components in their own products.

Over the past several years, QLogic's quarterly revenue has been stagnating or decreasing year over year. This is probably a consequence of the maturing of some of QLogic's key markets, such as the fibre channel adapter market, as well as of a generally unfavorable IT spending environment.

As can be expected, the price of QLogic's stock has followed revenue, decreasing from around $17 in 2011 to its current level around $12. But the recent stock price is actually the result of slow, but steady growth over the last several months. What has been happening behind the scenes to justify a cautious increase in investor confidence?

Recent changes within QLogic
Over the last year, QLogic has been undergoing its own restructuring. This started in May 2013, when then-CEO Simon Biddiscombe unexpectedly resigned. The board started a search for a replacement and appointed CFO Jean Hu as interim CEO.

Then, in early June, QLogic announced plans to cut annual costs by $20 million -- operating expenses stood at $267 million in 2013 -- and according to management, this plan is progressing ahead of schedule. There was also a decision to discontinue certain unsuccessful product lines, notably the ASIC switch business.

On the other hand, QLogic has been focusing on areas of strength by acquiring some product lines from its competitors. In January 2014, QLogic bought Brocade's fibre channel adapter business. In February, newly appointed CEO Prassad Rampalli led the acquisition of Broadcom's ethernet adapter business for $147 million, a deal that QLogic estimates could lead to an immediate gain of $45 million in yearly revenue.

However, in spite of the acquisitions, it's still not clear if QLogic can begin to reliably grow its revenue. On the third-quarter conference call, management said that with a favorable IT spending environment, they expect to see revenue growth in 2014 driven by new product cycles. Even so, the growth is likely to be modest for a while as design wins slowly transfer into paying business. 

In conclusion
QLogic is carrying out a restructuring involving cost cuts and a more focused product line. Similar changes have already resulted in big stock-price gains at peer company Brocade and might result in gains at Juniper Networks.

While QLogic's stock price has been slowly increasing over the last several months, it is unlikely that it will make a significant jump until the company finds a way to achieve stable revenue growth. Looking forward, keep an eye out for QLogic's revenue report in the current quarter to see if it is becoming a good investment.

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