Please ensure Javascript is enabled for purposes of website accessibility

The Momentum for Gigamon Inc. Continues

By Chris Kuiper, CFA – Feb 17, 2016 at 9:47AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

This small-cap tech company put up another great quarter, and it appears more growth is ahead.

Source: Gigamon.

A few months ago, I noted that Gigamon (GIMO) was a relatively unknown small-cap tech company that deserved a look after announcing a great third quarter, with future prospects of focusing on the cybersecurity trend. On Jan. 28, the company announced fourth-quarter and year-end results for 2015, confirming cybersecurity has indeed paid off and is set to propel growth further into 2016.

Gigamon ends 2015 strong
Gigamon reported revenue of $67 million for the fourth quarter, well above consensus estimates of approximately $63 million. Adjusted earnings per share similarly trounced expectations, coming in at $0.29 versus the expected $0.23, or 26% higher. Management also guided revenue for the next quarter to be between $61 million and $63 million, beating analysts' expectations of only $56.8 million and representing a 32% year-over-year growth rate.These figures helped propel shares 18% higher in trading the next day, though the stock has since dropped back and closed Tuesday at 7.6% above its pre-earnings-release price.

This past year was a marked improvement compared with 2014. Not only did revenue grow by 41% for the year, but gross margins also expanded by three full percentage points, from 77% to 80%, and the company is now profitable on a GAAP basis.

On each quarterly earnings call or investor presentation, management likes to make a big deal about its "seed and grow" sales strategy, and rightly so, as it is impressive. This is the idea that new customers usually start with small orders but then continue to buy Gigamon products and services almost every consecutive quarter as they realize the benefit of the products.

For example, 90% of bookings in the past quarter came from existing customers, and the top 25 customers all made continued purchases. In fact, the largest customer has made purchases for the past 34 consecutive quarters. If your customers keep coming back and wanting more, it means your product is working and sales aren't coming from just burning through new customers. Although, Gigamon does keep adding new customers as well -- 300 new accounts in 2015, to be exact.

Security is a big driver
Gigamon's products are used to help network administrators see and gather the appropriate network traffic they need without slowing down all of the other traffic. This is especially important for security purposes.

For the entire year of 2015, over 45% of Gigamon's sales were related to security in one form or another, compared to only 36% in 2014. Management expects this to increase to 60% for 2016, and in the last quarter the three largest new customers were all security-related. "Our momentum in the security market continues to increase ... " CEO Paul Hooper said in a press release. "We enter 2016 with increased leadership in our market and continue to execute with conviction and predictability."

It should be noted that Gigamon does not compete with network security providers such as Palo Alto Networks (PANW 3.19%) or Fortinet (FTNT 0.99%). Rather, they are complementary products, as Gigamon's appliances efficiently extract and send the appropriate data to these security products for them to deal with. Instead, Gigamon competes against the old, incumbent switch providers, such as Cisco Systems (CSCO 1.64%).

Given the now two consecutive quarters of excellent growth and future prospects, Gigamon is a very attractive growth opportunity. Back in November, the stock looked expensive on a trailing price-to-earnings basis, but if future growth was considered, it was trading at a more reasonable P/E ratio of 30.

Now it's trading at an even cheaper forward price-to-earnings ratio around 20, as estimates have come up and the stock has seemed to have been unfairly whacked with the rest of the market and tech companies. Therefore, this might be a nice opportunity to pick up some shares, especially before its market cap gets bigger and the institutional investors start to notice.

Chris Kuiper has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems and Palo Alto Networks. 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.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.