Barclays Mellanox Technologies
Buy the Omni-Path Overhang
Stock Rating/Industry View: Overweight/Neutral
Price Target: USD 60.00
Price (22-Jul-2016): USD 45.61
Potential Upside/Downside: 32%
Tickers: MLNX
Takeaways from Meetings with Eyal Waldman, CEO, and Jacob Schulman, CFO
With the stock still reeling from a mixed earnings report last Wednesday evening, we hosted meetings last Friday (22 July) with CEO Eyal Waldman and CFO Jacob Schulman. The primary focus and concerns we have heard from investors is the threat that Intel’s Omni-Path is taking share in the HPC market. We were encouraged that investors also focused on growth opportunities including Spectrum switching, 25/50/100GE adapters and even the intelligent NIC market. While we expect investors to consider the Intel threat carefully and we expect the threat to be an overhang on the stock, we think these concerns are overblown in the context of the current valuation and are confident that MLNX’s Infiniband business will grow in 2016 and 2017. Our comfort level is based on our own assessment of the trends in the HPC market over the past several years that we have been following and is further supported by management who noted that they have a bottoms up model that gives them confidence in this forecast.
In our view investors are discounting MLNX’s clear strength and leadership in the highest end of the Ethernet market – 40GE and the emerging 25/50/100GE market. Ethernet growth beyond the large push by hyper scale data centers will be driven by a combination of Spectrum switching, LinkX cabling and transceivers, NPU-platforms and the new BlueField multi-core product. Our $60 price target is based on 15x our 2017E EPS of $4.05. Currently trading at 11.3x our 2017E EPS, we view the valuation as compelling given the growth opportunity and in the context of the average 18x FY2 P/E MLNX has traded at historically.
Main Themes from Meetings
Assessing the Omni-Path Threat: Intel announced 8 system wins in the TOP500 list released in June and we don’t think it’s unrealistic to think Intel can take 10%-15% share of the HPC market. Assuming one-third of the TOP500 HPC list refreshes each year that means there are just under 170 new systems up for grabs each year. Approximately 70 of these would have to go to MLNX to maintain its current Infiniband market share, leaving just under 100 systems that Intel could target without impacting MLNX’s current share – Omni-Path can take share from non-Infiniband fabrics as well. Not all of these will upgrade to 100G but even if just half do (MLNX expects most will need to go 100G), there is more than enough room for both Infiniband EDR and Omni-Path to coexist.
Performance will also be another measure to monitor going forward. Right now, MLNX management has stated that Intel is being aggressive on price and essentially buying market share. MLNX noted that some bids from Intel for systems were priced at or even below FDR (56G) solutions. Pricing is a concern we are monitoring but given the stability in gross margins this quarter, we are comfortable with the discipline being demonstrated by MLNX. HPC now represents under 40% of MLNX revenues and those are the only systems primarily upgrading to 100G today. The other markets Infiniband serves today upgrade at slower rates given qualification times and cost sensitivity so those are currently not facing the threat from Omni-Path.
2017 will also start seeing Exascale systems deployed. The first deployments of CORAL, a system deployed by the Department of Energy, will begin in 2017 and MLNX has already announced its EDR solution there. We model 10.5% growth in Infiniband revenues in 2017. Even if Infiniband revenues are flat year-over-year in 2017, and all else remains the same in our model, we see just a $0.10-$0.15 impact to EPS.
Incremental Ethernet Opportunities: Ethernet revenues were strong in 2Q16 and even after adjusting for EZchip (we assume $26 million in revenues), core MLNX Ethernet likely grew 12%. Spectrum switching was the focus here and MLNX already has one hyperscale customer using. With Intel focusing on Omni-Path, the switch market has been left to just MLNX and Broadcom.
For adapters, we do not expect MLNX to maintain the 75%+ market share it has at 40G at 25/50/100G but this market is likely 8x-10x larger in the long-term so dominant share is not necessary for driving revenue growth. Right now, we expect this market to be dominated by MLNX and Cavium. Similar to HPC, we expect both can perform well without having a significant impact on MLNX’s growth prospects, though we do believe MLNX will take dominant share. While 1Q16 was clearly just a sampling quarter, MLNX is the only vendor in the survey with measurable product in the field and its share right now is 100%. These speeds amounted to about $2 million in revenues for MLNX. We find it interesting that all the ports shipped at these speeds are currently copper - we expect optical based solutions to dominate these speeds when the industry migrates fully.
Our 30% revenue growth that we forecast assumes 9% growth in EZchip revenues and translates to $100 million in incremental Ethernet revenues in 2017. This could prove conservative if Spectrum hits its internal targets and is at $10 million per quarter by the end of 2016.
MLNX Quarterly Revenue Composition by IP and Data Rate
Source: Company Reports & Barclays Research |
