Xyratex Swims in Public Pool

The first storage company to go public in 18 months received a tepid welcome today when Xyratex Ltd.'s (Nasdaq: XRTX) IPO price of $14 came in below its expectations.

When it filed to go public earlier this month, Xyratex hoped for a share price between $15 and $17, which would let it raise up to $128 million (see Xyratex Files for IPO). Instead, its sale of 6.96 million shares raised $97.4 million. Of that, $52.2 million goes to the company and the rest to investors and underwriters, including Credit Suisse First Boston Corp., Citigroup, Banc of America Securities LLC, and RBC Capital Markets.

Still, Xyratex has gotten the IPO ball rolling, and other storage companies intend to follow the U.K.-based company this year. So far, Xyratex competitor Engenio Information Technologies Inc. (see LSI Storage Becomes Engenio) and blade server startup Egenera Inc. have filed to go public (see Egenera Files for IPO, Robert M. Dutkowsky, President, CEO & Chairman, Egenera, and Egenera Generates $30 Million). Egenera filed for its IPO within hours of Xratex's pricing, but has not scheduled a date for its own pricing. Engenio spokespeople originally targeted the end of June for its IPO pricing, but it appears now it will wait until at least next month.

Xyratex sells storage systems to OEMs and test systems to disk drive manufacturers, and its competitors include Adaptec Inc. (Nasdaq: ADPT), Dot Hill Systems Corp. (Nasdaq: HILL), and Engenio. It spun off from IBM Corp. (NYSE: IBM) in 1994.

According to SEC filings, Xyratex had net income of $17.9 million in the first quarter of this year on revenues of $119.3 million, after losing $52.5 million on revenues of $99.4 million the previous quarter. The 2003 loss was due to a $57.5 million charge related to stock compensation the company took in November. Xyratex estimates it will report revenues for the quarter ended May 31 of about $108.1 million, up from $75.4 million for the same quarter last year.With 28 million shares outstanding, Xyratexs market cap is $392 million. Trading of Xyratex shares on Nasdaq opened at $12.71, before moving up to $13.67 in early afternoon.

Why the disappointing price? Two factors seem to be operative -- the company's low gross margins and its losses last year ($47.3 million for 2003). Gross margins from Xyratex’s storage systems division, which account for most of its sales, were 17.4 percent last year. In comparison, Dot Hill had margins of 24.3 percent over the same period.

Also, Xyratex expects to take another charge for an estimated $180 million for stock compensation this August.

Investors might also be concerned that Xyratex relies mostly on three large OEM customers. Network Appliance Inc. (Nasdaq: NTAP)accounted for 45 percent of its 2003 sales, followed by Seagate Technology Inc. (NYSE: STX) with 22 percent and Western Digital Corp. (NYSE: WDC)with 11 percent.

It's not yet clear what effect Xyratex's experience may have on its competitor Engenio's IPO pricing. According to Engenio’s SEC filing, it had net income of $6.9 million on revenues of $115.8 million last quarter and net income of $15.7 million on revenue of $426.7 million for 2003.Engenio has said it is on target to go public by its original date of the end of June, which is less than a week away. Now it looks like it won't make the move until July.

“If I were Engenio, I would wait a little,” says analyst Kaushik Roy of Susquehanna Financial Group. “The market is down, storage stocks are down more than 20 percent since the beginning of this year, and overall the market is a little jittery at this time.”

But analyst Steve Berg of Punk Ziegel & Co. thinks Engenio might be encouraged by Xyratex's breaking the ice that's covered storage IPOs for the last two years. “Engenio should be happy there are IPOs in the storage space,” he says.

Seagate was the last storage company to go public in December 2002. Storage software company CommVault Systems Inc.

is another candidate for an IPO this year (see CommVault 'Well Positioned' for IPO and CommVault Locks In Dell).

— Dave Raffo, Senior Editor, Byte and Switch0