I present the following write up because its important to view both sides of the coin. That being said, I also like to invest "prior" to the turn around actually happening. Yes, there is more risk involved, but you beat the herd and get a much better price this way ($5.25 for me)
In addition, IOM continues to allow you to day trade for 5-10% gains per shot. God bless America
Fred
Why Iomega's "Turnaround" is a False Alarm Analyst: Chris Bulkey (11/6/98)
Is Iomega (NYSE: IOM) the turnaround story of November?
In the past week alone, its shares have risen more than 60%, to close Thursday at $9.00, after the company posted a smaller-than-expected third quarter loss, hired a new CEO and watched a competitor, Syquest Technology (NASDAQ: SYQT) file for bankruptcy. Iomega was recently quoted today at $9.13.
But, hold your buy tickets. We don't think the share price appreciation is warranted given the many challenges facing the computer storage device maker.
OK, so Iomega's third quarter loss of $0.03 per diluted share was narrower than the First Call Estimate of a $0.05 loss. Big deal! The positive surprise came from cost cutting, period.
Falling Revenue
Revenue growth remains non-existent, as the top line fell 9% to $392.8 million. Even more disturbing is the fact that sales have fallen on a sequential basis for the past three consecutive quarters. Doesn't look like the company is building any sales momentum, does it?
Next, look at gross margins. For the third quarter, this key profitability measure continued its steady descent. Due to a larger mix of OEM sales and price cuts (a response to industry-wide price cuts), gross margins fell to 22.3% from 32.5% last year. A company can only cut costs for so long. Eventually it must reinvigorate the top line and expand margins if earnings are to grow, let alone turn positive.
There are also several reasons to believe that revenue and margin trends will not reverse anytime soon. As mentioned earlier, Syquest said it was going out of business. The news, which caused Iomega shares to rise on Tuesday, is overrated. Syquest may be gone, but its products will be around for a while. Syquest has a lot of inventory to clear out, which it will likely sell at huge discounts. Even though purchasers of Syquest drives will not be able to get customer support, the prices will be so cheap it will be like buying a disposable product. That does not bode well for Iomega's fourth quarter, which management predicted will show a profit.
Cash is Way Down
Balance sheet and cash flow trends don't look good either. Cash is alarmingly low, down over 30% from last year's third quarter, to $45.6 million, or about $0.17 per share. That's a direct result of awful operating cash flows over the past few quarter. Although third quarter cash flow figures are not yet available, the two previous quarters consumed more than $250 million from operations.
Poor cash flows also help explain the dramatic increase in debt. Total debt has increased 51% from last year, to $169.5 million, bringing the debt to equity ratio up to 43% from 28%. Mark Cohodes of Rocker Partners, a long-time Iomega short-seller, notes that the company violated its loan covenants twice this year. A credit crunch may be lurking if cash flows don't improve quickly, and current market conditions certainly do not make this a good time to be in need of raising capital.
Then there is the issue of competing technologies, of which there are several that offer greater capacity than Iomega's removable disk storage solutions. An example is DVD drives, which are more expensive but will likely fall in price over the next few years, as competition heats up and the products become commoditized. Analysts concur that serious threats from new technologies are at least a year away, but they cast more doubt over Iomega's outlook nonetheless.
Another event that boosted the share price over the past week was the announcement of a new CEO, Jodie Glore, the former COO of Rockwell Automation. I'm sure he's a talented person, but Jodie Glore is not exactly a household name in the disc drive industry. Besides, it took nearly almost nine months to complete the process. Why did it take so long? Was he the first choice? Besides, there is still no chief financial officer, and I generally make it a steadfast rule to avoid companies in the midst of managerial change, especially those without a CFO to give accurate guidance to the Street.
Valuations Not Cheap
Finally, let's look at management's guidance and valuation. Management has guided the Street to expect earnings of $0.25 per share in fiscal 1999. If the company does not regain sales growth and stop the gross margin erosion, that forecast may prove to be aggressive. Regardless, a $0.25 estimate for next year values the shares at over 30 times forward earnings. The shares also trade at 1.5 times sales and 6.8 times book value of $1.49 per share. Those are certainly not cheap valuations. Says Howard Rosencrans of HD Brous and Co., who is skeptical of Iomega's turnaround story, "Iomega is a one product company with a business model that shows no evidence of working."
Bottom Line:
Stay away from Iomega, given that it's trading at over 30 times earnings estimates, has declining sales and margins and sells a highly priced competitive product. |
