Silicon Graphics International (SGI) Analysis


Randy of Durig Capital has brought you two ideas, DIVX and LAB, that played out well immediately, so here is his third.

Is it Silicon Graphics International’s time to shine?

Is Silicon Graphics International [[SGI]] third time a charm? Now that they have rock solid balance sheet, excellent execution and very low enterprise value, is this SGI’s time to shine?

Our goal is to select, purchase and monitor companies in an effort of gaining outstanding performing investments while minimizing risk for our clients. We will cover part of our review and selection process as well as explain why SGI has currently become one of our selections.

First, you should know the following: On April 1, 2009, SGI filed for Chapter 11, again, and announced that it sold all of its assets to Rackable Systems for $25 million. The sale increased to $42.5 million and was finalized on May 11, 2009.

At the same time, Rackable announced their name change, Silicon Graphics International, as their global name and brand.

We first search for companies with pristine balance sheets

After the purchase and name change, the new SGI has roughly $154.8 million in cash, or $5.10 per share, and no long term debt after completion of the December quarter.

SGI has a very strong balance sheet.

We like extremely low enterprise values

When you subtract out the cash from the enterprise while remembering that SGI has no debt, their enterprise value (the value of the ongoing operations of the company) is actually extremely small for a company that just completed a single quarter with over $150 million in pro forma revenues.

If you subtract out all the cash from the remaining value of the company, the ongoing business is only worth about $218 million. This makes the business value smaller than the just completed quarterly revenues, which is remarkably low for a leading computer company with a run rate well above $500 million in revenues.

SGI is achieving size, scale and many competitive advantages while only having a handful of competitors. Additionally, having an impressive ability to leverage new business revenues in both storage and services while attaching more value onto to their established and strong position in server sales, they have a nice business model.

Is the operation or enterprise driving value to their shareholders?

SGI receives another yes.

They had an outstanding quarter with a 18 cent pro forma profit, which is well above the average estimate of a loss of 8 cents while solidly expanding and, better yet, forecasting a continuously expanding margin for the year.

Possibly even more impressive is that SGI grew their cash this quarter by over $31 million, which was a whopping 25% greater over their last quarter.

An impressive metric measurement of their execution was that the new SGI’s international revenues are up about 12 times in one year to 29% of total revenues. With this knowledge and the history of SGI, the new SGI has strong execution and growth.

Now knowing the excellent performance on the international markets, SGI’s current forecast of doubling storage business in three years to 30% of total revenues seems very palatable.

In most companies this would be seen as a Hercules-type of event, especially in this economy. For SGI though, it’s just part of normal execution.

Is this a good business?

We believe this is a very good business with both new and established clients adopting a slow but steady migration to a cloud-computing concept of computing, while at the same time the cost of high performance computers is rapidly falling.

This allows for a high growth, low cost, open-architecture computer company to be in a very enviable position.

SGI is a leading developer of enterprise-class, high performance systems that feature individual configurations that could include thousands of Intel x64 based microprocessors with Linux operating systems. The standard combination of Intel x64 architecture and Linux operating environment combined with their own differentiated Linux extensions gives companies that purchase SGI advantages in improved performance, simplified system management, reduced operating cost and a much more robust development environment.

When Rackable purchased the assets of SGI, they also attained over 700 patents in the high performance computers as well as many large customers.

Is the Train Wreck and then the fog from the Wreck clearing?

When finding companies around cash value, often a “Train Wreck” is needed to drive value close to cash.

With SGI, it was assumed it was a never ending train wreck, but some of the major concerns include:

  • Questionable success of two uniquely different companies merging, knowing the more established one never gained success in years.
  • SGI’s history of having great technology, but poor sales or execution.
  • Questioning if Rackable would be able to provide it’s high growth, while accruing a much larger company.
  • In 2006 and 2009, SGI went into bankruptcy giving SGI without proper due diligence – the concept that SGI is a perennial looser.

I believe all of these factors and more have been priced into this company’s current price.

First of all, SGI will survive if it’s profitable with a high pile of cash and no debt.

Rackable Systems (the purchasing company) had a completely different story and went public in June, 2005.

According to Gartner’s October 2007 server report, Rackable Systems was the fourth largest x86 server provider in North America. Also, in 2007, it was rated the fastest growing server provider in North America, outgrowing all the majors like Sun Microsystem, Dell, Hewlett Packard and IBM on a unit percentage basis. With Rackable Systems (the little guy) purchasing SGI (a technology leader), this could come out far better than it has been priced for.

The new SGI has now demonstrated over the last two quarters that the execution of Rackable Systems combined with the technological muscle of SGI to date has been a wonderful marriage, with some of the best execution in the business whether we perceive them having a low enterprise value or not.

Valuation

We believe SGI has a value, execution and balance sheet like those past companies that fit our model, e.g., SONS, LAB, DIVX, KHD, HCII and WCG, so we’re hopeful that SGI will have a similar outcome knowing other companies that fit this model have preformed well.

Knowing that SGI has completed two excellent quarters in creating value for their shareholders and now that the new company has completed over 6 months of history, we ran the following two traditional valuations of SGI to put a value on the new company:

1. Price Earning or PE Based:

Durig Capital is currently forecasting that SGI will produce an annual run rate of 72 cents per year pro forma. With SGI’s margins, revenues and profits all expanding, SGI should at least achieve some industry parity in value.

When the Diversified Computer Industry’s average PE of 17.55 is applied to SGI, this would give ongoing business a value of $12.63. Then, when you add the cash of $5.10 per share, we believe that SGI could achieve a stock market value of $17.73.

2. Revenue Based:

If you value SGI at 2.48 times sales (again, the computer diversified sales average) using SGI’s guidance of $500 million in sales for their current year plus the $5.10 in cash currently on the books, it adds up to a $46.50 stock market value.

Either way, today you could easily demonstrate based even on the lowest result (the PE based valuation) that with SGI’s current model, low valuation and especially with their short term superb execution, SGI could and should, in our opinion, be valued significantly higher.

Disclosure

Durig Capital owns SGI in it’s client, related and own accounts. We started buying around $8.89 per share.

  • Randy thanks for letting me put this up.
    I have a question about the valuation. Given your multiples provide a value in excess of $17, what margin of safety would you use? You bought at $8.89 and probably bought around Jan but what would you consider to be a good entry point now?

    Do you also use other valuation methods?

  • And would RAX be considered a competitor?

  • mark feldman

    kind of hard to buy over 20% higher than your purchase price. Was there a reason to wait so long before posting?

  • Ken

    RAX could be considered a competitor in one of their spaces. RAX and SGI both provide a cloud computing offering. However RAX does not sell hardware. SGI does. Specifically SGI sells super computer hardware and with the purchase of Rackable they now offer high density computing hardware. It appears as though SGI’s cloud service is aimed at technical or scientific customers that specifically are looking for high compute power. Where as RAX is a general hosting provider and their cloud offering is more aimed at companies that want to move their IT infrastructure to the cloud.

    Rackable was a provider of high density hardware solutions to google at one point in time (not sure if they still are). But for example SGI after buy rackable would be in a good space to sell hardware to cloud providers where as RAX does not do that.
    .-= Ken´s last blog ..Festival of Stocks #178 February 1st 2010 =-.

  • Hi Jae,

    Thanks for posting the article, your first question, “what margin of safety would you use?”

    We try to protect our clients by providing a margin of safety, by trying to model in extremely low values, like rev’s, or a good example is some of your article’s on negative enterprise values, to us this is our protection.

    I’m still building a positions in SGI, but at a much slower pace, I was (pleasantly) caught off guard how much it moved and how fast.

    Do you also use other valuation methods? Three main tenets in our selection criteria.

    1) Value, negative enterprise is good for example.
    2) Business model, the more monopolistic the better, for investments.
    3) Management execution, This is also protection, SGI is executing at a very high level.

    RAX could be a client.

    Again Thanks

    Randy Durig
    http://investment-income.net/category/investments/high-cash-stock-review

  • I see. I’m not too familiar with networking and IT equipment, but why would companies buy cloud computing hardware when the purpose is to reduce expenses and maintenance cost through cloud computing?? Unless you mean, SGI sells to companies like RAX who then provide cloud computing to the end users.

  • Great question Jae,

    I use my laptop, work, and home computers, not to mention any mobile devise, to communicate both professionally and personally.

    I want only one pull down for say my e-mails(from the clouds) no matter the underling platform or computer. You and I have shared, a Google doc, that is a cloud application.

    So in the future you, say you buy a music video, you will want the sound and entertainment provided on any platform you own, rent, or visit, and updated to all platforms with any keystroke. Not just on a single PC. So the app’s/music can follow you (like a cloud)even if you go to say, wine county:)

    So since RAX provides music, and other cloud services, it will need a high level of hardware and storage to support it’s tremendously large level of app,s (like music selections)to possibly just as many platforms.

    So I beleive cloud commuting like RAX and SGI is the future, and SGI has a good position/business model, supporting companies like RAX.

    I know this valuation is Apples to Grapes and is wrong, but I also beleive you protect your clients by finding companies with very low valuation.

    So since RAX is value about 4 sales and SGI is about .5 sales. Based on that single simple model, SGI could have about 8x stock increase to equal RAX current price to sales value.

    Hopefully, you can understand why SGI make’s a very compelling investment for my client’s.

    Thanks again

    Randy

    http://investment-income.net/category/investments/high-cash-stock-review

  • Ken

    Agree with what Randy said for the most part. However I think cloud “commuting” is still a ways off and I think its too early to say how end user’s platforms will evolve. But it is clear service providers are all starting to offer some form of cloud based hosting. Look at how many web hosts there are now, that is cloud computing in the future. Companies like Amazon, Rackspace, Verizon, etc… All offering cloud or utility computing solutions will be buying hardware from someone. SGI/Rackable is in a good space to sell it to them. But keep in mind there are big competitors here (HP, etc…).

    Also in response to Jae’s question. There is also a need for “private clouds” that companies can host internally. Some companies are reluctant to host their customer data and IP in the cloud because of the multi-tenancy nature of the proudct and the security implications. However they do like the ease of provisioning that the cloud model provides. Allowing developers/QA, sysadmins etc… to deploy virtual servers with the click of a button saves a ton of time. So big companies will be building out their own internal cloud infrastructure. But really this just equates to more server purchases with new software on top of it.
    .-= Ken´s last blog ..Festival of Stocks #178 February 1st 2010 =-.

  • Ken

    To revise my previous comment. I read Randy’s comment a little too fast and thought he was referring to the entire client PC platform being hosted in the cloud which I think is still unclear. But it does look like more and more software moves from the end device to the Internet. Yes applications are trending towards the hosted model (salesforce.com, google docs, MSFT’s competitor to docs, etc…).
    .-= Ken´s last blog ..Festival of Stocks #178 February 1st 2010 =-.

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