Emulex tumble shows storage stocks returning to Earth

That the storage networking company succumbed to the fears gripping technology investors should not be a surprise. The truly amazing thing is that it took this long.

3 min read
That Emulex succumbed to the fears gripping technology investors should not be a surprise. The truly amazing thing is that it took this long.

Emulex gave up almost half its value Monday on worries that customers are delaying purchases. The maker of products for connecting to storage networks could post no quarter-to-quarter revenue growth in the third quarter if the trend continues.

Compared with the rest of the tech industry, storage networking stocks have held up reasonably well during the past several months. Emulex has done especially well, trading just below its all-time high as recently as three weeks ago.

The stock hit that near peak after Emulex reported a strong December quarter. Investors took heart after the company raised targets for the first three months of calendar 2001.

Company executives on Friday said they still could hit those optimistic goals, though not if clients keep delaying orders into later quarters. Under the worst-case scenario, which shareholders are certainly expecting, Emulex's revenue won't grow at all from the second quarter.

Because Emulex is the market leader in its niche, Wall Street took the company's report as an excuse to abandon every stock related to the field. The list of hammered issues included Emulex rival QLogic, switch maker Brocade Communications Systems and Emulex client EMC, the largest seller of the systems that make up storage networks.

Analysts' reactions were mixed. Credit Suisse First Boston's Amit Chopra saw no reason to change his opinions. U.S. Bancorp Piper Jaffray's Ashok Kumar took Emulex's warning as further evidence for his long-standing thesis that Internet Protocol-based storage networking is displacing the fibre channel technologies that fuel business for Emulex and Brocade.

Robertson Stephens analyst Ara Mizrakjian said Emulex is suffering from an inventory glut partly caused by the decline of dot-coms and exacerbated by strong December sales that resulted in lower demand during the current quarter.

None of the analysts fretted about long-term demand for storage networking products. Corporations have too much data to stash.

Given that long-term view, some may have questioned why these stocks were hit so hard. The companies were expected to take some kind of hit, but were a 48 percent decline for Emulex and an 18 percent drop for Brocade too harsh?

Not necessarily.

The storage networking industry has remained expensive throughout the decline of the overall technology market. Heading into this week, Emulex was valued at 80 times estimated earnings for the next 12 months. Brocade traded at 120 times expected profits. EMC and QLogic were the cheapest of the bunch, trading around 50 times expected profits.

Emulex became particularly ripe for picking in the last couple of months. The company wasn't benefiting merely from seemingly strong fundamentals. It separated itself from peers when it carried a 2-for-1 split on Dec. 18. Since then, Emulex has stayed in positive territory while other storage networking stocks have lost ground.

Meanwhile, funds and traders were having fun with Emulex. Last year's Emulex hoax--in which a fake press release sent the company's shares on a roller-coaster ride--probably helped by drawing more attention to an already popular stock, making it even more liquid.

More than a few short sellers jumped in as the stock ascended during the fall and early winter. By early January, 8 percent of the float was being shorted. That's not as much as the shorting of popular dot-coms such as Yahoo or Amazon.com, but it's a lot more shorting than is typically found with solid tech names. Short sellers are investors who attempt to profit from a declining stock.

All of that attention was bound to catch up with Emulex. One stumble is all it takes to bury stocks in such a lofty position.