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Network Engines (NENG): Slowly Making Progress

Posted on February 7, 2007

About a year ago, we picked Network Engines (NENG) as a potentially solid turnaround candidate in the technology sector. Back then, the stock was trading at $1.88 per share and the company was losing money. Fast forward one year, and the company is now trading at about $2.25 per share, up nearly 20%, and reported $6 million in free cash-flow for the most recent fiscal quarter.

Overall, given the above statistics, we can´t complain much about our investment in the company. In any turnaround situation, stabilization of cash-flow is the first priority, and management has clearly been very successful on that front.

However, renewed revenue growth, the second important aspect of any turnaround, still remains a concern at Network Engines. With 82% of revenue coming from EMC, the company is in dire need of new revenue streams. On that front, even though the company has been successful in attracting new partners, there has yet to be any meaningful financial impact from these deals. Generating new revenue is, of course, far harder to achieve than cutting costs and we therefore plan to have some more patience to wait for top-line growth.

Furthermore, we think that patience makes sense here, because with $39 million in cash, no debt, and no cash burn, the company has plenty of resources and time to establish new revenue streams, especially considering the booming nature of the appliance industry.

Additionally, with about 40 million shares outstanding, the company´s enterprise value is around $50 million, or less than 0.5X EV/TTM Sales. Though this low relative valuation is somewhat warranted given the reliance on EMC, it should be clear that “The Market” is not pricing in any meaningful sales growth potential for Network Engines.

Therefore, as we mentioned over a year ago, in the event that the company is successful is developing new non-EMC business, the shares could appreciate significantly. In the meantime, as mentioned above, we see little downside risk given the strong balance sheet and already depressed valuation.

Disclosure: We hold shares in NENG. This report includes market analysis. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets or in any particular stock. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise. We maintain no legal responsibility to update this report or his holdings in the stock mentioned in this report

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This site may include market analysis and we may own shares in the stocks mentioned in our reports. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

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