Intel-Triggered Boom and Bust Ending for Mellanox Bulls

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Gilad Shany remembers well his bet two years ago on Mellanox Technologies Ltd.

First, there was the boom: Shares doubled in just three months amid speculation that an Intel Corp. server upgrade would lift sales at the Israeli technology company. The bust was just as breathtaking -- a four-month plunge that wiped out all of those gains. Shany, who helps oversee $26 billion at Baron Capital Inc. in New York, managed to sell some, but not all, of the shares he held before the crash.

He’s undaunted.

As Intel rolls out yet another server upgrade for high-performance computers, Shany’s piling back in. This time will be different, he says, because Mellanox no longer counts on supercomputers as its sole market and because sales stemming from the new server, known as Grantley, will be more evenly spread out over time. Investors and analysts agree. The stock has climbed 15 percent this year while the number of analysts recommending the shares doubled to ten.

The Intel upgrade is “happening along with Mellanox’s business model becoming more diversified,” Shany said by phone Oct. 13. “That’s the major difference.”

Mellanox, whose products power supercomputers crunching data for everything from high-frequency trading to weather forecasts, has expanded to supply customers with less intensive needs such as Yahoo! Inc.’s search engines and International Business Machine Corp.’s cloud services.

Growth Catalyst

Shares of the Yokneam Elit, Israel-based company have rallied 48 percent $45.77 from a 2 1/2-year low in June. They rose 5.4 percent last week, beating a 0.5 percent gain in the Bloomberg Israel-US Equity index. Mellanox slipped 0.2 percent to $45.67 as of 9:56 a.m. in New York, the first drop in three days.

Intel server processor upgrades generally prompt server owners to upgrade their machines, which in turn creates demand for Mellanox’s products.

One key cause of the 2012 stock bust was that sales from Intel’s upgrade, which was delayed for several months, rocketed on pent-up demand and then quickly petered out.

Mellanox will benefit from the new upgrade for four to six quarters, the company said in an e-mailed response to questions.

While analysts say Intel’s upgrade will be a catalyst for Mellanox’s growth, the world’s largest computer-chipmaker itself is also a competitor. Intel, based in Santa Clara, California, is developing its own upgraded data transfer technology, called Intel Omni Scale Fabric, designed to support high performance computers, the company said June 23. The new technology will be available in 2015.

Competing Product

“Fabrics is an unquestioned priority for Intel,” Eoin McConnell, a product line director at Intel, wrote in an e-mailed response to questions this month. “Intel takes any competition seriously, but we believe we have a compelling road map.”

Mellanox will begin offering new adapters in the “2014-2015 time frame” that can move data at 100 gigabits per second, Chief Executive Officer Eyal Waldman said on a July earnings call with investors. That’s more than twice as fast as the competition, said Andrew Nowinski, an analyst with Piper Jaffray Cos in Minneapolis who has a buy recommendation and a $50 price target for the stock.

Waldman, a former Intel employee, has an advantage over Intel because he’ll beat his larger rival to market with a faster solution, Nowinski said.

“Mellanox has a four-quarter runway here of uncontested growth,” he said by phone Oct. 8. “It’s really up to Mellanox here to stay ahead of them and come out with a faster speed and stay ahead of the curve.”

Intel Threat

In a July 16 note entitled “Giddy about Grantley,” Jefferies analyst James Kisner upgraded Mellanox to buy from hold, arguing that while the company faces a “significant threat” from Intel in the long term, that’s unlikely to materialize until at least 2016.

Not everyone is convinced that Grantley will be a home run for Mellanox.

“From an investor perspective, it’s a show-me story given past experience,” Ashok Kumar, an analyst with Imperial Capital LLC in San Francisco, said by phone Oct. 8. Competition from Intel’s data transfer product “could potentially take some of the wind out of the sails.”

Sales at Mellanox are forecast to rise 15 percent this year to $448 million, compared with a 22 percent drop in 2013, according to the average of 16 analyst estimates compiled by Bloomberg. Mellanox reports third-quarter earnings today. Sales increased 12 percent to $117 million, analyst estimates show, compared with a 34 percent tumble in the year-ago period.

The company says about half of its revenue comes from supercomputers. Mellanox estimates the potential market for its Web services and cloud infrastructure business at $4.7 billion in 2014, up from $1.1 billion in 2013.

Intel will be too focused on threats to its core microprocessor business from rival ARM Holdings Plc to steal serious market share from Mellanox, according to Shany of Baron Capital.

“Intel has bigger fish to fry,” he said. “If you really want to build an optimizer infrastructure to the picosecond, you have to use Mellanox.”