7 Takeaways From Mellanox Technologies, Ltd. (NASDAQ:MLNX)

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Mellanox Technologies, Ltd. (NASDAQ:MLNX) prides itself as the maker and vendor of high-speed networking solutions. The company’s networking equipment targets operators of server clusters such as Facebook Inc (NASDAQ:FB) and Microsoft Corporation (NASDAQ:MSFT).

Although Mellanox initially narrowed its focus to the high-performance computing (HPC) market, it has been actively diversifying its revenue sources. Other segments the company operates in include hyberscape, storage and cloud.

What makes Mellanox a successful vendor of enterprise networking equipment? Innovation puts Mellanox head and shoulders above peers. The company’s technology is actually several generations ahead of the competition. More advanced product technology and expanding product portfolio are some of the sources of strength in Mellanox.

Growth catalysts

Mellanox has consistently expanded its revenues over the last five quarters and the management sees no break to topline growth in the coming years. For example, the management is confident that the company will continue to grow in every part in 2016. Already, 2015 has been a growth year Mellanox with revenue expanding from $120.7 million in 3Q2014 to $171.4 million in 3Q2015.

  1. Switching segment

Ethernet Switching is one segment where the management of Mellanox expects to see continued robust growth in the coming years. Mellanox hopes to drive growth in switching business by deepening relationships with or reaching out to large customers. Microsoft, which sources its switches from Arista Networks Inc NYSE:ANET), could be a target customer for Mellanox to deepen relationship with. That school of thought is supported by the fact that Mellanox offers more affordable and more advanced end-to-end switches compared to Arista. As such, Mellanox can leverage its superior product technology and competitive pricing to fuel growth in switching segment.

Because Arista currently generates about $80 million every year from Microsoft, Mellanox could bring a significant boost to its topline even if it partially displaces Arista as Microsoft’s switch suppliers.

  1. HPC segment

The future looks bright for Mellanox Technologies, Ltd. (NASDAQ:MLNX)’s HPC business, which is its largest operating segment. Penetration into the large enterprises market and increasing adoption of HPC by government institutions around the world make a favorable case for Mellanox’s HPC segment.

The launch of Broadwell server chip by Intel Corporation (NASDAQ:INTC) is also likely to fuel gains for Mellanox in HPC business.

  1. Storage segment

The shift from legacy hard-disk drives (HHDs) in computers and servers to solid-state drives (SSDs) is expanding storage opportunities for Mellanox and its peers. The storage sector can been growing strongly in 2015 with the growth expected to remain strong in 2016.

Given its reputation in storage solutions and business networks, Mellanox looks poised to ride the server storage upgrade wave, thus boosting topline gains.

  1. Acquisitions

Mellanox Technologies, Ltd. (NASDAQ:MLNX) complements internal efforts with purchased advantages. As such, over the years the company has grown both organically and inorganically and the strategy is not about to stop.

Currently, the company has a merger deal pending. Mellanox wants to add EZchip Semiconductor Ltd (NASDAQ:EZCH) to its portfolio for about $811 million in a cash transaction. The acquisition of EZchipis not only expected to complement Mellanox’s existing efforts, but also bring in the capabilities that the company needs to deepen and diversify its play in data center processing and adjacencies.

Mellanox’s other strategic acquisitions in the recent years include IPtronics and Kotura, each of which brought unique technological capabilities, leading to significant increase in revenues and profitability. Additionally, the acquisition of the two assets enabled Mellanox to advance its leading in high-speed networking equipment market to 100Gbs data rates.

Pressure points for Mellanox

  1. Threat from Intel

Intel is posing a threat to Mellanox Technologies, Ltd. (NASDAQ:MLNX)’s Infiniband business with its OmniPath, and the consequences could be far-reaching. Intel’s OmniPath is headed for commercialization starting 1Q2016.

Mellanox currently controls the largest share of the Infiniband market, about 85% to 90%. In 2014, the company Mellanox captured 92% of total Infiniband revenue, according to data from Gartner. However, it is Mellanox’s market dominance in Infiniband market that is set to come under threat as Intel brings its OmniPathto market next year.

Boasting higher performance rating and coming at a discount of about 50% to Mellanox’sEDR, OmniPath is a serious threat to the Mellanox’s Infiniband business. Further threat to Mellanox is that Intel is plotting to integrate its OmniPath to CPU by 2017.

Not only is OmniPath threatening to limit Mellanox’s sales opportunities in the Infiniband market, but also temper its margins. With its market dominance, Mellanox has tended to enjoy above corporate average gross margins in its Infiniband’s business.

Nevertheless, Mellanox could still defend its turf in the contest for the Infiniband market by projecting its EDR as more efficient than Intel’s OmniPath. Already, Mellanox is trying to argue that OmniPath is more resource intensive, demanding greater processor power than its EDR systems. If Mellanox succeeds in convincing customers to bet against Intel’s OmniPath, the company would sidestep the competitive pressure anticipated to come from the OmniPath commercializing next year.

  1. Customer turn into rivals

Mellanox Technologies, Ltd. (NASDAQ:MLNX)’s high-speed data center networking equipment are favored by large server operators. However, some of these customers can be seen either turning into competitors or at least taking the businesses in-house. Facebook is one of them. The recent move by Facebook to use home-backed switches reduces business opportunity for Mellanox.

  1. 3Q2015 earnings highlight

Mellanox Technologies, Ltd. (NASDAQ:MLNX) reported EPS of $0.75 on revenue of $171.4 million in 3Q, both EPS and revenue figures exceeded consensus targets. Revenue rose 42% from the same period last year.

The chart below shows Mellanox’s quarterly revenue trend:

1

Bottom-line

Mellanox Technologies, Ltd. (NASDAQ:MLNX) has impressive near-term prospects. While Mellanox’s long-term outlook could be clouded by rising competition from the likes of Intel and customers taking the businesses in-house, there is no serious threat currently.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Neha Gupta

Neha Gupta has been in the financial space for over six years now. Gupta earned her MBA degree from Symbiosis Centre of Distance Learning in 2009 and her passion for finance led her to pursue Chartered Financial Analyst (CFA) course. She has successfully completed Level II of her CFA. She is a veteran in article writing, which is depicted in her numerous pieces published on SeekingAlpha, Nextiphonenews, InsiderMonkey, MarketWatch, and Techinsider. Her crisp and eloquent writing finds its best place in Researchcows, where emphasis is given on developing rich content for various websites, products, business plans, trainings, and book writing.

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