COMMENTARY--VA Linux provides a fine example of why so-called cheap stocks usually aren't worth it.
The provider of hardware and services for Linux reported a lousy second quarter, told analysts to cut their fourth-quarter revenue forecasts by more than half and pushed profitability back to late 2002, which might as well be never, as far as today's market is concerned. VA Linux (Nasdaq: LNUX) stock is taking a predictable hit today on the news.
If you were looking purely at charts, you might have thought VA Linux was a safe bet, if nothing else. Over the past few months, despite an earnings warning last month and turmoil in the overall market, the stock seemed to establish a floor at roughly $7 a share:
Now the former star IPO is in a free-fall. LNUX sell orders outpaced buys by more than 4-to-1 early this afternoon on the Island ECN.
Things probably will stabilize temporarily as short-sellers--they owned 10 percent of VA Linux as recently as a month and a half ago--cover their trades. But in the long run, there's nothing to hold up this stock. There's justification for buying it except blind faith.
And blind is the operative word here. During yesterday's conference call with analysts, VA Linux executives sounded more uncertain about the future than other tech companies facing the same tumultuous market.
"Frankly we find it difficult to give guidance for future quarters," CEO Larry Augustin said.
VA Linux basically is planning for the worst. The company is now aiming for revenue of less than $30 million, a figure that can only be described as pathetic. Profits have been pushed back three quarters to October of next year.
Yet should anyone really be surprised? The dot-com crash is old news. And even casual observers of the computer industry had to know that major players like Dell (Nasdaq: DELL), Hewlett-Packard (NYSE: HWP), Compaq (NYSE: CPQ) and IBM (NYSE: IBM) weren't going to just forget about Linux.
Companies like VA Linux say the entry of Big Players is validation for the field. But validation doesn't preclude competition.
The largest computer hardware companies are successful because they're in tune with corporate customers. If corporations want Linux, companies like Dell and IBM will give it to them.
In the end, VA Linux is just another box seller, and a tiny one at that. The company says its technical expertise is a competitive advantage. Maybe, but IBM Global Services and Compaq's enterprise arm might beg to differ. So would any systems integrator, for that matter. After all, we're talking about Open Source, which is designed to be accessible to anyone; no one with technical minds should be a disadvantage.
Given that kind of competitive backdrop combined with a slumping IT market in general, it's a wonder that VA Linux was trading as high as it was. VA Linux going into yesterday's earnings report carried a market capitalization of $385 million, or roughly double its assets of $192 million at the end of the second quarter, if you exclude goodwill. As of this afternoon, the company was valued at $293 million and change.
That's an expensive price for a company whose growth prospects look shakier than jello in an earthquake. It will appear even pricier at the end of April, because VA Linux expects to burn about $30 million of cash in the current quarter.
Even if you're holding onto the stock in vain hopes of a buyout, an acquirer isn't likely to pay much more than the base value of VA Linux's cash and property, or somewhere between $3 and $4 a share.
That's assuming anyone wants to buy everything VA Linux has to offer. No box maker would bother with the company's hardware business, which is mostly based on off-the-shelf parts. The engineering talent can be poached. The Web sites should cost a pittance.
It's not worth it for anyone else to buy VA Linux as a whole. It would be easier to keep competing and let the company struggle.
You can find a similar situation with plenty of "cheap" stocks. They're usually cheap for good reasons. And it's usually cheaper for investors to avoid them. 22GO>