Smith Barney Research Commentary
Box Hill Systems Corporation# (BXH, $7.38,
1-H)
Upgrading Box Hill Systems to 1-H from 3-H
We are upgrading Box Hill Systems Corporation (NYSE:BXH) from the
current 3-H (Neutral, High Risk) to a 1-H (Buy, High Risk) on Monday,
August 31. Recent developments indicate to us that the company seems to
be back on track in a number of fundamental ways.
1.We have increased confidence in the current quarter due to positive
signs in the company's traditional businesses. We believe that the
company's traditional financial and telecom business remains solid.
We also have indications that the company is growing business in new
markets, such as video. We have also heard about Storage Area
Network implementations for the first time. The recent hiring of a new
sales team in the Western US from a former Box Hill reseller is a
strong plus. The company gains a much-needed presence in one of its
largest potential markets with a experienced team that is familiar with
Box Hill's products.
2.Consultations with the rest of the Salomon Smith Barney technology
team resulted in a more positive consensus outlook for the technology
industry in general in the fall season, particularly among the PC and
networking markets. We believe that these are good indicators of
returning demand in the open systems server market, where Box Hill
gains the vast majority of revenues.
3.Recent press releases on the company's new software and hardware
products indicate to us that the company is moving in the right
direction. We believe that the industry is moving towards a more
segmented storage market - that the requirements for one application
are not necessarily the same as those for other applications. We have
examined in detail the range of products that Box Hill offered in its
recent press release concerning OOpen Network Storage,O and we
believe that these are appropriate to the emerging segmentation of the
storage market. We must stress that this tailored, customer-centric
approach to the market is not a new strategy for Box Hill - the
company has always focused on this. What is new is that Box Hill's
focus on new markets such as video require additions to the
traditional line of products. Importantly, the Fibre Box is still in this
lineup (as the ONS 8000) as is the traditional SCSI RAID Box
Turbo+ (the ONS 5000), but Box Hill has recognized the need to
provide a broader range of solutions to suit its customers.
4.We believe that the most important new product area is Box Hill's
emerging line of integrated software products. We have noted
previously that the single greatest practical barrier to the effective
implementation of Storage Area Networks (SAN) is the software
needed to integrate the various hardware pieces and manage the
whole as a complete solution. This combines the disk, tape, and Fibre
Channel networking pieces of the SAN into a working whole. We
would not want to over-hype the capabilities of the individual storage
management software products. However, we do believe that,
together with some of the interoperabillity testing that the company
has done, the software provide the basis for true value-add. Box
Hill's expertise in integrating complex SAN systems will likely
differentiate it in this important emerging market.
5.We believe that some of the groundwork the company laid in the
beginning of the year in the multimedia and video editing markets is
beginning to pay off. We expect that the quarter could begin to show
some of the first small contracts in this area.
There are two main risks to the company. First, the SAN opportunity is a
large one that has attracted a number of competitors. Currently, we note
three pioneers in the development of SAN management software; Box Hill,
StorageTek, and Data General. StorageTek is an ally, which needs Box
Hill's integration expertise to sell its disk storage, and we therefore believe
that the two companies' software development will actually be
complementary. Data General has a very popular product in the Clariion,
but pursues an OEM strategy. We believe that SANs will require integrators
to implement, which is a focus that Data General's server OEMs lack. Box
Hill has made this focus the center of its strategy. With the ONS 4000,
5000, 8000, and 9000, Box Hill will be able to cover a range of individual
needs.
The second risk will be Box Hill's ability to execute on its vision. The
company still carries the execution risks that come with being a mid-sized
player in the market. That is, it must grow its geographical presence and still
strike the delicate balance between its excellent service and support
reputation and controlling operating costs. To this point, the newly hired
West Coast team is a welcome addition, as was the previous hiring of the
Southeastern Regional sales head. Further, we believe that the company will
be supported by its increasingly close relationship with StorageTek, and it is
hiring a number of pre- and post-sales support personnel. So the risk of
Box Hill's geographic "reach" falling short is a diminishing, though it is not
eliminated.
OUTLOOK AND VALUATION
We have not changed our model for the company since the end of the first
quarter, but recent developments have increased our confidence in our
estimates. We believe our current quarter estimates of $22.6 million in
revenues and $0.16 in earnings per share are achievable. Not only was
backlog strong going into the September quarter, but there are signs of life in
new target markets. Our fourth quarter revenue and earnings per share
estimates are $26.6 million and $0.19, respectively. The company should be
aided in achieving these by the strong sales team it just hired, as well as
accelerating growth in the target markets of video. Moving into 1999, our
estimate is for total revenues of about $110 million and earnings per share of
$0.75. Assuming that the new target markets begin to move in the next six
months, and that current traditional markets hold, our estimates for 1999
could be conservative.
The company also has maintained a strong balance sheet, with book value
of over $4 per share. Its cash pile of almost $50 million should support its
ability to grow into its new found markets. Both of these factors should limit
downside in the stock from its current levels.
When we analyze other companies in the storage subsystems business, we
find a startling split in valuations. As a universe of disk array companies, we
examined Ciprico, EMC Corporation, MTI Technology, Network
Appliance, and Procom Technologies. On the average, these shares closed
on August 28 at a forward twelve months' earnings per share multiple of
23.5, according to our calculations. The group is clearly split between
high-flying stocks like Network Appliance and EMC, and those that are
falling behind, such as MTI Technology, Procom, and Ciprico. EMC closed
at a forward 12 multiple of 31 and network Appliance at 50, while the other
three closed at an average multiple of 12. All three of the companies with
lagging multiples fell short of the street estimates last quarter, while the
leaders exceeded estimates by at least two cents. The lagging stocks also
endured significant downward revisions in earnings per share estimates last
quarter.
Box Hill exceeded estimates by two cents last quarter, and earnings per
share estimates moved upwards for 1998. And despite a stumble in the first
quarter, earnings per share have remained positive and grew sequentially in
the June Quarter by 50%. By our model, the company could return to a
revenue growth rate in the range of 30% by the fourth quarter, by our
model. Yet its shares still trade below the range of other rivals who have
stumbled in the past quarter. Although it does not yet deserve the premium
multiples of the high-fliers, we believe that it should not be lumped in with
the laggards.
As a rule of thumb, we have found that hardware stocks tend to trade at
forward twelve months' earnings multiples of about one-half of their
projected revenue growth rates. With an expected revenue growth rate
moving to about 30%, we believe that Box Hill should move towards a
multiple of 15x, as it convinces investors that revenue and earnings growth
are back on track. At its current share price of $7, it is trading at a multiple
of about 11 times our current forward twelve months earnings per share
estimate of $0.63. We therefore believe that the shares currently represent a
very significant value, given the company's lower risk profile.
Further, we project that in twelve months the shares will be trading in the
range of 15 times the forward twelve months earnings per share projection.
In that time frame, we believe that forward twelve earnings per share will
move to about $0.83. At our target multiple of 15, this yields our target
price of $12.
Release Date: 08/31/98
A description of our rating system is available in our Guide to Risk and
Performance Ratings.
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