One of the large hedge fund investors in Emulex Corp. dashes off angry (or disappointed) letter urging immediate action.
We have been tracking the Emulex Corp. odyssey for a while now. In July, we noted that that ELX jumped on rumors of a strategic transaction and Underdisclosed.com favorite, Starboard picked up a big stake.
Starboard has been doing its homework on Emulex and doesn’t like what it found. Starboard send a letter to Jeffrey W. Benck, the Emulex President and CEO, and the board of directors. In the letter, Starboard noted that over the past five years, ELX declined over 40% prior to July 3, 2013, the date of the first news report speculating that the Company had engaged a financial advisor to explore strategic alternatives. In addition, as of July 2, ELX was $6.66, which is 39% lower than the $11.00 all-cash offer to acquire Emulex made by Broadcom Corporation in 2009 that the Board rejected.
Starboard still sees hope for Emulex, including the core fibre channel HBA product, which it anticipates will generate strong cash flow for several years. Starboard even discounts the notion that it is a declining technology with newer competing technologies. Starboard also applauds Emulex’s 10Gigabit Ethernet (10GbE) and Fibre Channel over Ethernet (FCoE) businesses, which Starboard notes have grown dramatically and achieved leading market share positions.
After discussing the good, Starboard gets to the crux of the issue: poor capital allocation decisions. Translation: Emulex does not know how to invest money. Its acquisitions don’t work out and its R&D doesn’t pay off. As a result, shareholders do not trust management:
“Management has made a habit of announcing large acquisitions and investments, setting unrealistic growth expectations and then lowering those expectations over time. This has forced investors to heavily discount management’s guidance, contributing to the depressed multiple at which the stock trades.”
Among Starboard’s list of horribles:
- EBITDA margins have declined from 34.8% to 10.7% as growth in operating expenses has far outpaced growth in revenue.
- Research & development expenses have doubled and have consistently exceeded 30% of sales, yet Emulex has been growth-challenged in recent years.
- The continued increase in expenses has compounded the impact from the decline in the fibre channel business.
- The $10 million of announced cost savings during the quarter only partially offsets the increase in spending associated with the acquisition of Endace Limited and is by no means sufficient to offset the years of growth in operating expenses without commensurate revenue growth.
And then Starboard lowers the BOOM, discussing capital allocation issues. Over the past 10 years, Emulex has spent more than $2.4 billion on investments, including:
- $900 million on acquisitions;
- $1.3 billion on research & development; and
- $230 million on capital expenditures.
What are the results of these massive investments? Since 2003:
- ELX has declined 76%; and
- Emulex’s enterprise value has been reduced to less than $600 million, a small fraction of the historical investments made.
Starboard believes it is time for change, specifically, a newly reconstituted board of directors comprised of independent directors and shareholder advocates.
Starboard also proposes that the board of directors adopt a financial and strategic discipline backed up by performance targets for management
With the Elliott Associates’ standstill agreement with Emulex drawing toward expiration, things could get interesting with two of Emulex’s biggest shareholders.