Is Mellanox Technologies Readying for an Epic Run?

Mellanox Technologies (NASDAQ: MLNX  ) was, a long time ago, a darling of Wall Street. The company's stock enjoyed a robust run from about $33 per share to nearly $120 per share as a result of a series of quarterly earnings beats resulting from "pent-up" demand for high-performance computing related products. As it became clear that the couple of "big" quarters were temporary as this demand was satisfied, the long-term growth models that investors and analysts alike had constructed fell apart, taking the share price with it. However, the stock may now represent a compelling opportunity ahead of a potentially large refresh cycle.

Intel's Grantley could be a major growth driver
The high-performance computing market is lumpy, as sales typically ramp up upon the launch of a new platform from Intel (NASDAQ: INTC  ) , eventually followed by falling sales before the next platform. Rinse and repeat.  Ideally, through the peaks and troughs, the overall trend is up as the market for high-performance computing grows. According to Intel, the market for high-performance computing chips (to which Mellanox sees a pretty healthy attach rate), should grow very nicely over the next several years.

Source: Intel.

With the high-performance computing market forecast to grow by double digits, and with increasing compute performance driving the need for ever faster and lower-latency network performance, Mellanox should be well positioned to capitalize via both Ethernet (lower performance, but lower cost and a more competitive market) and InfiniBand (higher performance, but more expensive).

More to the point, Intel's next-generation platform known as Grantley should reinvigorate the high-performance compute market, particularly as the performance and power improvements over older platforms drive a lower total cost of ownership. That platform should launch in the third quarter of 2014, and as a result Mellanox's results should accelerate throughout the year.

The downside
The big "fear" -- and probably what could derail this thesis -- is that Intel is trying to cut Mellanox out with its own Ethernet and InfiniBand offerings. Intel has been a competitor in Ethernet for years, but its foray into InfiniBand -- which has been Mellanox's crown jewel -- began with the chip giant's acquisition of QLogic's (NASDAQ: QLGC  ) InfiniBand assets in early 2012.

The good news for Mellanox is that QLogic's efforts were far behind what Mellanox was offering; as a result, the near-term competitive picture is heavily in favor of Mellanox's solutions. However, Intel has signaled that it plans to be more aggressive in developing InfiniBand products. Furthermore, Intel has made it clear that over the long haul, it plans to integrate key InfiniBand functionality into its Xeon and Xeon Phi processors -- potentially cutting Mellanox out of a fairly substantial chunk of business.

How should investors think about this?
In the near-to-medium term, Intel's InfiniBand efforts are unlikely to prove a particularly large threat to Mellanox's business. Indeed, while Grantley has not yet launched, preliminary leaked materials suggest that this platform does not integrate InfiniBand functionality into the processor. This means that until Intel's next big platform launches in mid-2016, Mellanox should be pretty safe.

Even once Intel has integrated this functionality, the rest of Mellanox's business -- which is exposed to Web 2.0, cloud, and storage (which are all set to grow nicely, per the Intel slide shown above) -- should continue to grow nicely, offsetting any share loss in InfiniBand.

One more thing...
A final angle to consider is that Broadcom (NASDAQ: BRCM  )  has now freed considerable resources as a result of its divestiture of the cellular baseband business. Broadcom could try to buy Mellanox as it seeks to grab more content share (InfiniBand adapters and switches) in the data-center space and to drive further consolidation in Ethernet, an area where Broadcom is the leader.

Foolish takeaway
The challenges facing Mellanox are real, and this stock hardly seems like a "slam dunk" from a deep-value perspective. Still, sentiment seems to have bottomed out following last quarter's miss, and the financials appear set to get quite a bit better as the Grantley platform begins its ramp later this year. Near its 52-week low and with $7.55 per share in net cash on hand, the risk/reward for this name looks compelling for tech investors not afraid of a volatile, small-cap tech stock.

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