July 24, 2011 - 11:41pm EST by
2011 2012
Price: 30.00 EPS $0.23 $0.17
Shares Out. (in M): 78 P/E 130.0x 176.0x
Market Cap (in $M): 2,340 P/FCF 0.0x 0.0x
Net Debt (in $M): -220 EBIT 18 16
TEV ($): 2,120 TEV/EBIT 117.0x 132.0x
Borrow Cost: NA

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With Facebook & Apple as customers, FIO had a high flying IPO in June.  But they are losing support of marquis customers, fierce competition is entering, margins will be commoditized, and the insider unlock date of Dec 5 is the circled day on everybody's calendar inside the company.  Valuation leads the tech pack at 17x ttm sales of $136m for a $2.36B market cap, and over 175x 2012 estimated EPS of $0.17.  

Fusion-IO Inc. provides data center efficiencies by moving active data closer to the CPU.  They sell a flash-based storage memory solution for servers along with associated software that allows a user's data to be called into flash memory when they log-on for faster delivery. 

The cheapest secure way to store data is still traditional hard drives, but seek times are slow relative to solid state memory.  The concept is to have a "zero" layer on your HDD server stack which temporarily calls up user specific active data into solid state memory when needed.  There is definitely a giant market out there for this type of enhanced data delivery and current market penetration is only ~1-2%. 

There are some very interesting applications for this technology such as the ability to instantly view your hundreds of friends when you log into Facebook, or calling up your library when you log into iTunes. Ever notice that an online retailer can't show you many thumbnails of their products without data delays, yet facebook delivers thumbnails of all of your friends instantly?  It is because the retailer hasn't invested in a solid state flash layer to deliver you data, likely because of high cost.  

Marquise customers....
Facebook was 52% of revenue in the March quarter and Apple was 20%.  With 72% of sales to these tech favorites it is no wonder they were a very hot IPO.  But, Facebook is done buying.  They purchased ~5000 server cards for a new data center in the March quarter.  They say they will not be building another data center for at least a year, so the next 3 to 4 quarters of revenue from FIO's biggest customer will be zero.  Street models are hopeful that Apple will fill the gap however Apple uses ACS to source this part of their biz and they are not indicating any changes.   So it looks like the 52% customer will be missing when they report.  The CFO is quick to point out the extreme lumpiness of their business by warning investors this "is not for the faint of heart".  Regardless of sales worries they should be able to pick up some of the slack from other customers, although it is doubtful they'll reel in names of matching clout.
Extreme pricing will be commoditized...
Currently (and not for long) Fusion-IO may be the performance leader, but they are certainly charging for it in full.  A typical server costs around $5000, but to add their server card more than doubles the price. Facebook spent $35m for ~5000 cards which implies $7000 per unit.  FB vaguely said 'approximately 5000' but we do not know the exact quantity for certain. FIO had a 53.2% gross margin in the March quarter. This was down from 58.7% in the Dec quarter which makes some sense considering they likely gave a volume discount to close with FB and get the large jump in sales. 

An add-on to your server that costs more than the entire server is quite expensive.  Consider that on Dell's website you can add-on a solid state 100GB drive to any server for under $1950, and a 50GB for under $980.  Granted you'd need to write your own software to tell it to load a user's active data when they log-on, but I don't imagine there's much magic in that although FIO touts their software lead on the competition.

Competition is coming... Well, actually it has arrived...
There really wasn't a direct alternative in the server side flash market until OCZ launched it's "Z-drive R4 PCIe SSD line" which starts shipping in July.  Here's a few other competitive offerings arriving this year:  EMC's 'Project Lightning' arriving 2H'11,  MU's 'RealSSD P320h' arriving Q3'11,  INTC's '720 PCIe SSD' card arriving Q4'11,  STEC's 'Enterprise PCIe SSD' has no specified delivery date yet but they say year-end.  There are plenty of additional players with various offerings including NetApp, Virident, and Violin Memory. 

If you were the CTO of an enterprise, wouldn't you wait 6 months to compare all this new stuff before spending heavily per server with FIO?  If you're FB or AAPL, don't you think all these entrants will be gunning for your business with highly aggressive prices?

As investors, consider that other tech IPO high-flyers have come out of the gate strong with a few big name customers on the books (like Rackable Systems), only to disappoint when competition quickly crowded out their margins and stole their big accounts. 

Trailing sales through March were $136m and street models have them at $190-275 for 2011 and $250-365 for 2012.  This assumes the sales relationships with both FB and AAPL grow, though I think that is quite suspect.  There's also talk of 5% penetration on 4 million deployed servers at $5000 per server which implies a billion of sales... I think it's more like an eventual 20% penetration on a commoditized $400 per server price for $320m in sales.  If that happens, this short will work out well. 

The bullish sales numbers also assume that FIO will add onto it's product line at similarly high margins.  Currently their product is for cache-ing where there is a willingness to pay up for performance.  Assumed product add-ons for replication and backup likely won't be able to garner the high price tags because they are far less performance driven where people care about security rather than speed.

With Q2 already put to bed but not yet reported (assuming a report date circa Aug 10th), I sense a feeling of impending doom from insiders.  Dec 5th is unlock date for 66.5 million shares or 84% of shares outstanding.  New Enterprise Assoc has 33% and Lightspeed Ventures has 11%.  Another 16% is held by insiders.  Maybe we'll see a no proceeds secondary.

So, there is heavy pressure on to keep sales rising.  And, they're pretty cashed up with their upsized IPO proceeds of $219m.  With 5 months until unlock date, I've seen this combination cause management teams to lose their minds by offering deals with the cash.  Basically buying sales they need to hit targets and please the street by funding some of their customer's purchases.  I'll be looking carefully at the accounting for sales, returns, deferreds, and cash.  Hopefully they won't fall into temptation, but these situations have shown that a lot of basically good people can do nutty things when there's $2B of market cap on the line.  The Chief Legal Officer was at Wilson Sonsini in the tech go-go days so I'll bet he's seen this kind of stuff.

Lastly, there is a patent infringement lawsuit filed against them by Internet Machines LLC that seeks damages and a permanent injunction.  Though I have no read on whether the case has merit, management says it relates to a 3rd party manufactured switching component so they believe their products are not infringing.



- Loss of marqee customers
- Commoditization of margins / Entrance of heavy competition from EMC, OCZ, MU, INTC, NTAP, etc.
- Insider unlock Dec 5th
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