STEC Inc. (NASDAQ:STEC): Well positioned for growth in 2010 - Deutsche Bank

Deutsche Bank is very positive on STEC Inc. (NASDAQ:STEC) reiterating their Buy rating and $36 price target and calling the stock their Top Pick for 2010.

Firm notes they view STEC as the best pure-play way to play adoption of SSDs in the enterprise market. While adoption of SSDs into enterprise applications appears to have stalled modestly in the second half of 2009, due to its early stage of development, limited competitive offerings, more difficulty selling to mainstream buyers, and concerns about the technology, they believe SSDs offer performance benefits in enterprise applications which will ultimate drive adoption. In firm's view catalysts for adoption include lower NAND prices, additional suppliers, automatic tiering software, and the transition to 6 Gb/s SAS. Over the longer term, SSD units are expected to grow at a CAGR of 149% through 2013, with units forecast to double in 2010 and 2011. With ample room for multiple suppliers, they view STEC as well positioned to benefit from its first mover advantage and continue to grow revenue considerably, as the growth of the market will likely far outstrip ASP declines and market share losses.

Inventory overhang at EMC; what’s priced in?
In early November, STEC reported its F3Q-09 quarter, with results and guidance generally in line with expectations. However, the news that put a cold chill through investors’ hearts was the disclosure that STEC’s business with EMC was not selling through at the levels originally expected. As a result, EMC had excess inventory of SSDs in 3Q and would possibly have additional excess inventory in 4Q. While STEC did not provide specifics on the number of drives in inventory or on why SSD sales had seemed to stall, the company did put a sales incentive plan in place to encourage its customers’ sales people to sell SSDs. Because EMC has already committed to buying $120M in SSDs during 2H09, the excess inventory is unlikely to impact 4Q results, but will potentially create an overhand in 1Q-10 when EMC potentially slows down purchases of new SSDs as it works down its inventory. As seen in Figure 1 below, a potential stall in EMC business is significant, as EMC represented 54% of STEC’s sales in 3Q and accounted for 87% of ZeusIOPS sales.

While it is hard to assess the exact impact of the inventory overhand at EMC, based on Deutsche's industry checks and conversations with the company, they believe the magnitude of the overhang is likely smaller than originally feared. EMC remains committed to SSD technology and currently has only qualified STEC for its storage arrays. While 1Q-10 may see some stall, the slow-down will likely be short-term.


Deutsche Bank’s assumptions
As a worst-case scenario, the firm views the above outcome as more dire than reality, but believes it is a healthy exercise necessary to assess the downside risk to results. Based on their conversations with contacts and with STEC management, they do not believe the inventory overhang is as large as this worst-case scenario suggests. In addition, Deutsche believes the typical strength in 4Q hardware sales, coupled with STEC’s sales incentive program will stimulate some demand in 4Q. Based on these assumptions, they assume EMC’s real demand for SSDs was roughly $8M short of actual sales in 3Q and will be roughly $10M short of targets in 4Q. As a result, they see an overhang of roughly $18M in sales in 1Q-10, which will be absorbed by demand.

Notablecalls: Deutsche also discusses several topics including competition & why aren’t SSDs ramping yet. Expectedly, the conclusions are mostly positive. The call is 24 pg. long so it's a fairly thorough one.

Lately the stock has been a bit of a short-crusher & I think the comments from Deutsche will bring some additional pain for the shorts.

If they get this one going again, I see it trading $17-17.50+ in a jiffy. Short interest is still sky high and Deutsche's inventory analysis sure looks interesting.