Tuesday, December 4, 2012

QLogic: Likely Undervalued

Shares of QLogic (QLGC) have been thrashed over the last couple of years. But this is a well-capitalized company in a growing industry that is a market leader in many of its product segments.

QLogic trades for just over $800 million, despite cash and marketable securities of almost $500 million (against no debt), and earnings over the last four years of over $500 million. The market appears overly focused on the near-term, as sales of its networking hardware products are expected to continue to slow as enterprises (including many governments, for obvious reasons) cut back on large-scale purchases.

But for long-term investors, QLogic may be an attractive investment due to the current pessimism. As a market leader (e.g. in Fiber Channel), QLogic is able to spread its R&D out over more units, potentially providing the company an advantage over competitors. The company is currently high on its new Mt. Rainier line, on which the company's CEO opines: "There is no competition for this solution in the market, and I don't think anybody is going to be able to bring a solution to market for an extend number of years."

Don't expect any near-term revenue upticks, however. Product cycles in this industry are long, as first QLogic's products have to be incorporated into designs by its customers (for switches, servers etc.) and then those products in turn have to be sold to enterprises or other customers.

There is also constant pressure on price in this industry. More capable designs are always being created, which can make what's hot today look like a toaster tomorrow. Constant innovation is key, but because product cycles are so long, it can be difficult for investors to tell if a company's current R&D spend is effective versus the competition's.

There are also some caveats worth mentioning regarding the company's cash position and recent earnings. As you might have expected, a bunch of the company's cash and marketable securities are stuck overseas (lest the company pay some taxes for the right to repatriate that cash). Furthermore, the company saw a one-time $110 million gain in earnings last year as a result of a subsidiary sale.

When short-term pessimism reigns, an opportunity presents itself for long-term investors. As QLogic's price has continued to fall, it's looking more and more likely as such a candidate.

Disclosure: No position

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