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Q-Logic: A Cannibal Trading At Three Times Earnings

Headquartered in Aliso Viejo, California, Q-Logic Corporation designs and supplies high performance network infrastructure and connectivity solutions.

Spun off from Emulex and organized twenty years ago, the company is chaired by Harshad K. Desai – a director who, throughout the years, has cemented his reputation upon the virtues of prudence – and employs up to a thousand employees today.

The products Q-Logic sells enable the sharing of resources between servers and storage devices. These primarily consist of adapters, switchers, storage routers and integrated circuits.

Sold worldwide, their merchandise is in demand everywhere datacenters are administered. Tailwinds are massive as the world is going through a significant, secular explosion of computer information.

The company is known to exploit the best technology in its particular niche. It is widening its lead in the fibre channel – with a market share above 50% – and keeps actively developing its offer in the 10gig Ethernet category, where it stands as the second most serious contender, trailing Intel.

The traditional business continues to be solid and stable, and a significant growth opportunity has been identified in the converged networks segment. Combined together, sales to Hewlett-Packard, IBM and Dell weigh more than half of the $559 million revenue.

The chief competitors are Mellanox – $300 million in sales, and an archetypal Wall Street fad – Emulex – $500 million in sales, yet a company that struggles to reach profitability absent the required scale – and Brocade – $2B in sales, and a name paired with an excellent reputation.

The balance sheet carries $858 million in assets and $150 million in liabilities. Completely free of debt, the company sits on a net cash position of $484 million, more than half of the current market capitalization of $862 million.

Noticeably, the business demonstrates a consistent and growing earning power:

(free cash-flow per share)

2003: $0,73
2004: $0,70
2005: $0,83
2006: $0,33
2007: $0,99
2008: $1,27
2009: $1,48
2010: $1,17
2011: $1,53
2012: $1,29

At the current price of $8,8 a share, adjusted from net cash, Q-Logic’s stock trades at 3x earnings. This absurd valuation is likely connected to Hewlett Packard’s recent – and temporary in the author’s opinion – misfortunes, as the venerable firm led by Meg Whitman account for 25% of revenue.

Another attractive feature is the speed at which Q-Logic management buys back its own equity: It has shrunk its share count by half since 2004, and concentrated its largest purchases when the stock price got punished in 2007, 2009 and 2011.

Obviously, when companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.

Q-Logic stands out as an ideal acquisition target for a larger player wishing to expand its service offering, as an outright buyout would likely prevail on all the risks associated with the financing of a new venture.

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