Small Cap Enterprise Flash Stocks: Value Stocks or Value Traps?

On Tuesday, Enterprise flash stock Fusion-IO, Inc. (NYSE: FIO) sank 9.62% on an analyst downgrade in light of competition from Intel Corporation (NASDAQ: INTC), meaning it might be a good idea to take a closer look at it along with other small cap players like STEC, Inc. (NASDAQ: STEC) and OCZ Technology Group (NASDAQ: OCZ). Specifically, analyst Jason Ader with William Blair issued a report noting that his checks reveal weaker than expected bookings and an increasing competitive threat from Intel for Fusion-IO. And while Jason believes that enterprise flash will continue to see strong adoption, the PCIe cards Fusion-io mounts its flash chips on aren't going to sell that well. So he downgraded Fusion-IO from Outperform to Market Perform. One reason is that Intel offers a solution that is 30% to 40% cheaper and may even perform better. Fusion-IO is down 30.9% over the past year and down 20.2% since June 2011

Without getting into a complicated discussion over what enterprise flash drives, let’s just say they are designed for applications requiring high and consistent performance, reliability and energy efficiency. Jason wrote that he believes that enterprise flash is at an inflection point while demand for server‐attached PCIe cards is developing more slowly than he thought it would.

With that in mind, STEC, Inc. is worth mentioning as its a leading global provider of solid state drives, flash memory and DRAM modules. Last December, Balch Hill Capital, which holds a 9% stake in STEC, Inc., issued a letter that expressed “serious concern” about the company’s strategic direction. Balch Hill Capital’s letter noted that STEC, Inc’s response to intensifying competition has been to broaden its product line and dramatically increase its operating expenses (e.g. in research and development) to try and gain scale and compete, but there has been no commensurate increase in revenues or profits. Balch Hill Capital urged management to consider strategic alternatives that included a sale to hard drives or flash memory makers as a flash maker would get an immediate advantage because they would no longer have to pay a margin on buying the flash. The problem for investors in STEC, Inc. is that members of the family of co-founder Manouch Moshayedi are the company’s largest shareholders. Moshayedi was also CEO for 22 years until resigning last September after regulators filed insider trading charges against him. On Tuesday, STEC, Inc. fell 2.17% to $4.90 to $229.03 million for a market cap of $229.03 million. STEC, Inc. is down 49.8% over the past year and down 39% over the last five years.

Finally, OCZ Technology Group designs, manufactures, and distributes solid state drives and other computer components like flash or flash related software. Last December, the OCZ Technology Group submitted a plan to NASDAQ to regain compliance with the exchange’s listing rules. NASDAQ then granted an exception to OCZ Technology Group where the company must file its 10-Q for the period ended August 31, 2012 and all other delinquent periodic reports by February 28, 2013. OCZ Technology Group’s problems stem from accounting “issues” that could mean a restatement of earnings for several quarters, shareholder lawsuits over these accounting “issues” and being in default with the liquidity test and related financial covenants for their credit facility. On Tuesday, the OCZ Technology Group rose 0.91% to $1.98 to $133.80 million. The OCZ Technology Group is down 74.2% over the past year and down 54.5% since April of 2010.

The Bottom Line. Some investors might view small cap enterprise flash stocks like Fusion-IO, Inc., STEC, Inc. and OCZ Technology Group as being value stocks, but some could also make the argument that these value stocks are actually value traps that investors need to be wary of.