Though its stock is in tatters after a revenue shortfall, the company still has a pile of cash and the hope of luring big customers away from IBM and Sun
Sam Jaffe covers
investing for Business Week Online
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In terms of sheer destructive power, Wall Street's version of the wrecking ball is the preannounced earnings disappointment. That's when a company issues a press release before its scheduled earnings announcement date, saying it won't meet expectations for the coming quarter. In the current environment, nothing rivals the ability of such an announcement to reduce a company's market capitalization to rubble.
It gets even worse when, because of hopes for high growth, that company already has an inflated stock price. VA Linux' (
LNUX
) stock was similarly humbled on Nov. 6, when it preannounced a shortfall in revenue for its fiscal first quarter. Within seconds of the opening bell that day, the stock had lost 40% of its value. As of the market close on Nov. 20, the stock was priced at $11.75 a share, a mere shadow of its 52-week high of $320 a share and close to the issue price of its initial public offering last December.
STILL GROWING. But don't toss VA Linux onto the ever-growing trash pile of Net stocks that were once mighty. This company still has a good business plan, an admirable market niche, and a big pile of cash to keep it running until it reaches profitability, which should be sometime before the end of 2001. Despite that first-quarter sales hiccup, this company's revenues are still impressive.
VA Linux' primary business is selling huge server computers that are used primarily to host Web sites and that run on the Linux operating system, chief rival of Microsoft's Windows. One of the reasons VA Linux became such a popular stock was that venture capitalists were helping so many new Web sites open up, and typically, the first capital spending for them was a multimillion-dollar order for server computers. Thanks in large part to that market, VA Linux was able to increase revenues at a double-digit rate for each of the past four quarters.
But then a little thing called the bursting of the Internet bubble happened, and the flood of purchases by Web startups dried up -- fast. In VA Linux' fiscal first quarter, the company saw several handshake contracts -- worth more than $15 million -- evaporate. On the other end of each of those contracts were VC-funded Web startups.
HARDER SELL. So, what is VA Linux to do? No one expected it to live off the Net boom forever, but the sudden turn of events happened a little early for the company's growth plans. It now has to make up for the lost business by selling massive amounts of hardware to the enterprise market, otherwise known as really big companies. The problem is that most large companies already have entrenched relationships with the likes of IBM (
IBM
) and Sun Microsystems (
SUNW
), which sell competing servers. That "is a much harder, solutions-based sell than selling to Web startups that grew up with Linux," says VA Linux CEO Larry Augustin.
Nevertheless, such companies are allowing VA Linux to get a foot in the door. Of the $56 million in first-quarter sales, nearly 5% came from the large-enterprise market. That consisted of more than 30 contracts, all of them in the pilot stage. "The key is for [VA Linux] to convert those pilot projects to an enterprise-wide strategic shift toward using Linux and machines from VA Linux," says Chase H&Q analyst Walter Winnitzki.
As VA Linux makes the difficult transition to the enterprise market, it can gain some comfort from its $157 million cash hoard. Chief Financial Officer Todd Schull maintains that even if the company's future revenues don't increase, its cash would enable it to operate for 16 more quarters. But VA Linux execs don't intend to stand still. In fact, their growth plans are relatively unchanged and pretty audacious.
HIGH HOPES. The company expects to make $270 million in its 2001 fiscal year, which ends July 31, 2001. It also expects to reach a 27% gross-earnings margin by the end of the fiscal year, allowing the company to hit operating profitability at the same time. That's a pretty high margin for a computer maker, but CEO Augustin thinks the company can pull it off by trimming expenses and reaching sales targets over the next three quarters. "It only takes a little bit of a decrease in our expenses to produce profitability by the end of this [fiscal] year," Augustin says. Analysts expect the company to lose an average of 41 cents per share for the entire fiscal year of 2001 and earn 10 cents per share for 2002.
Meanwhile, the drastic drop in the stock price means shares of VA Linux are relatively cheap right now. The price-to-2001-revenue ratio hovers at 2.25. If you believe in the company's ability to successfully change its customer base, it will be hard to ignore such a low stock price.
Jaffe writes about the markets for Business Week Online in our daily Street Wise column
Questions or comments? Please visit our Ask Sam Jaffe interactive forum Edited by Beth Belton
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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