Thursday, August 03, 2006

Calls of Note Part 1

- Thomas Weisel Partners comments on Rackable Systems (NASDAQ:RACK) after management meetings and numerous calls with investors: The general summary they can provide after two days with management is that the Rackable story is not very well understood by the investment community and that firm's bullish outlook on the company's prospects (35-40%-plus top-line growth for several years with expanding margins seems likely) appear well justified, with strong long-term pipeline of opportunity apparently in place.

To summarize and answer the primary investor concerns they are hearing:

* Rackable is not losing one or more of its "Big 3" customers: All three are still ordering; Amazon was down as expected after strong rollouts, and one of the other two is pausing to re-evaluate Intel.

* Rackable is unlikely to lose significant business and margin due to the Woodcrest transition: Rackable wins on TCO, which is unchanged regardless of competitor or future processor chosen. Management has actually seen less aggression from Dell lately, but it is possible this could change, thus, continued steady gross margin guidance of 22-24% (long-term goal still 25-28%).

* Operating margins are NOT on a steady downward trend: Higher infrastructure spend is limiting operating margin while new salespeople ramp in the near term- TWP expects return to higher end of target 12-15% range once leverage is achieved (versus 10% assumption for 3Q06).

* Growth opportunities in new areas remain numerous: Large ($5mn) recent storage win a sign of things to come in that new market. Large 10%-plus deals in government and financial services appear on tap for 2007, while penetration of mid-level customers continues (50% q/q growth in the most recent quarter with five incremental $1mn-plus customers).

Valuation appears to be attractive: When accounting for the strong expected growth rate, shares appear to be trading at an attractive valuation of 15.4x 2007E EPS of $1.25, which represents just a 0.4x PEG rate, well below the peer group of 1.5x CY07E PEG.

Notablecalls: Not actionable but good to know category. RACK looks like a broken story providing only occasional trading opportunities.

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