Is There Any Value Left in These 4 Technology Stocks?

Emulex, QLogic, Brocade Communications, and Mellanox have all seen significant fundamental and stock losses, but are any now a buy?

May 14, 2014 at 12:05PM

The network solutions company Emulex (NYSE:ELX) has seen stock losses of nearly 30% in the month of May following poor earnings. Meanwhile, competitor QLogic (NASDAQ:QLGC) has lost 15% of its valuation in the same period, while both Brocade Communications (NASDAQ:BRCD) and Mellanox Technologies (NASDAQ:MLNX) have also lost significant value. Investors might try to find value here, but does it exist in any of these stocks?

A catastrophic performance end-to-end
Emulex is the quintessential behind-the-scenes technology company. It's one that sells a variety of products such as storage adapter cards, controllers, and switches to improve the end-to-end performance of data centers throughout the world. Over the last five years, Emulex has significantly underperformed the market, as the need for many of its best-selling products has diminished, which is also what we saw in its first quarter.

On May 1, Emulex reported earnings that then caused its stock to lose a quarter of its valuation. While its 6.1% year-over-year revenue loss caused the company to miss expectations, it was guidance for second quarter sales of $97 million that fell far short of the $115.7 million consensus. Notably, its EPS was also short of expectations.

Overall, Emulex's poor performance was a reflection of the industry. Nearly three quarters of its revenue comes from network connectivity, and it fell 9%. Specifically, server sales remain poor; IDC estimates that global server revenue declined 4.4% in the fourth quarter, an acceleration to the losses in prior quarters. This includes x86 servers, which have seen double-digit declines in recent months due to software innovations.

If we look even deeper into the catastrophic quarter of Emulex, its storage connectivity business, which makes up about 20% of revenue, has also suffered. It's expected to decline low double-digits this year and up to 30% next year.

Competitors also struggling
Emulex's quarter is a reflection of several industrywide changes within this space, specifically for QLogic, a direct peer. Emulex had already stated that its Fibre Channel, a small segment of its business, was seeing a greater-than-expected secular decline. This statement was a direct concern to QLogic and Brocade investors, two companies with a larger presence in the Fibre Channel storage market.

On May 2, the day following Emulex's quarter, QLogic announced its earnings, and confirmed a poor Fibre Channel market, saying it estimates the market declining by 6% this year. However, much of QLogic's weakness was hidden due to its acquisition of Brocade's adapter-card business back in January. Still, Piper Jaffray estimates that if you remove this acquisition,  QLogic saw a 4%-6% decline in organic revenue, which is a clear sign that this company is moving in the wrong direction.

As for Brocade, it won't report earnings until May 22, but given QLogic and Emulex's comments on Fibre Channel product sales – more than 60% of Brocade's revenue is derived from Fibre Channel switch sales – it would be a far stretch to expect a strong quarter and a risky bet to buy right now.

Even the bright spot is seeing turbulence
Despite all the bad news, each of the noted companies is attempting to grow market share in the growing 10G Ethernet space, which has been a bright spot across the board, but small in terms of fundamental impact.

Mellanox is considered a leader of sorts, with its InfiniBand Ethernet interconnect solutions for servers and storage. After seeing gains of nearly 350% in the year prior to September of 2012, Mellanox has since lost nearly three-quarters of its valuation as its space becomes more crowded. Even so, during its last quarter, the company saw revenue growth of 18.8%, and its InfiniBand was a hot topic on QLogic and Emulex's conference call.

Currently, InfiniBand is used for high-performance computing and in-line analytics. But the bigger question is whether InfiniBand is penetrating Fibre Channel and the enterprise space. If it is, this would be bad for traditional Ethernet providers like QLogic and Emulex, along with those heavily reliant on Fibre Channel, like Brocade.

Final thoughts
Even the single bright spot of these companies has come into question, although both CEOs remained skeptical of this InfiniBand transition. Overall, it's just one more reason to avoid all three stocks, which apparently lack even a glimmer of investment hope, and one reason that Mellanox's bad fortunes might be turning around.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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Jun 12, 2015 at 5:01PM

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