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New Type of Drive Spurs STEC Stock

Rising sales, profits and a near-monopoly on a new type of data storage drive have driven shares of Santa Ana-based STEC Inc. up more than 600% since the start of the year.

Last week, the company had a market value of $1.6 billion, up from about $220 million at the end of 2008.

The percentage gain is the largest among major stocks of companies based here so far in 2009. It bests,by miles,the Nasdaq (up 20%) and Standard & Poor’s 500 index (up 4%) for the same period.

The only local company that can claim a larger run-up is Irvine-based Diedrich Coffee Inc., which has seen its shares rise 6,000% so far this year.

But there are some big differences.

Diedrich, which supplies coffee to restaurants, stores and offices, still is relatively small with a market value last week of about $120 million.

The company has seen a surge as growth stock investors latch onto it amid improving results and rapid growth with K-Cups, which allow brewing of a single cup of coffee using a special machine.

Diedrich’s small amount of shares available for trading,Chairman Paul Heeschen and his Newport Beach-based Sequoia Enterprises LP own about 60% of the company,are a factor in its mindboggling surge.






STEC’s ZeusIOPS solid state drive: saw $120 million order recently

Some contend the company could be a takeover target.

STEC’s gain is more substantial. Where Diedrich has added about $100 million in market value since the start of the year, STEC has added about $1.3 billion.

Interestingly, the only local company that can claim a bigger gain in market value this year is Lake Forest-based disk drive maker Western Digital Corp., a looming STEC rival that’s added $4 billion in value.

Western Digital’s shares were up 145% for the year as of last week with a market value of $6.7 billion.

STEC makes a drive for storing data on computers and other devices that uses flash memory instead of the spinning disks found in drives from Western Digital and other disk drive makers.

Known as solid state drives for their lack of moving parts, STEC’s drives are logging big gains as more computer makers build them into their products,at the expense of Western Digital, the No. 2 disk drive maker, and Scotts Valley-based Seagate Technology LLC, the largest disk drive maker.

STEC’s drives are found in servers and data storage computers used by banks, insurance companies and others. They’re also used by the military.

The drives are more expensive than disk drives but are more durable and use less power.


Monopoly

For now, STEC has a virtual monopoly for solid state drives for networks, thanks to an early lead.

“Being at the right place at the right time and having strong technology in place only adds to their advantage,” said Jeff Schreiner, senior analyst at Capstone Investments LLC in New York. “2009 and 2010 are the beginning of a big transition with disk drives now starting to be replaced by solid state drives as a means for storage.”

STEC said earlier this month one of its largest customers ordered more of its ZeusIOPS solid state drives for the second half of 2009.

It now forecasts 2009 sales of the drives to reach $220 million, up from a previous forecast of about $160 million.

STEC didn’t name the customer. Most analysts believe it’s the company’s biggest buyer, Hopkinton, Mass.-based EMC Corp.

It also recently landed a $28 million contract with an undisclosed defense contractor.

STEC has been regularly upping guidance. The company is set to report second-quarter results on Aug. 3.

Sales of its drives have “been wildly exceeding expectations,” said Gary Mobley, senior analyst at Noble Financial Group in St. Louis.

“It was a niche that didn’t exist previously so nobody could predict how well it would do,” he said.

Analysts like solid state drives because they are one of the few growth areas left in the data storage business. They’re also more profitable than disk drives.

STEC’s ZeusIOPS drives get more than 50% profit margins, Mobley said.

Western Digital sees a gross profit margin of about 15% on average for its drives.

Last year, STEC moved the last of its manufacturing from Santa Ana to Malaysia, allowing for lower labor costs and a better tax rate.

That helped fuel profit growth and drive up shares, Mobley said.

STEC is supplying drives to the heavyweights of data storage. Along with EMC, customers include Hitachi Data Systems Corp., Sun Microsystems Inc., IBM Corp. and Fujitsu Ltd.

EMC has driven revenue growth for STEC this year. The company came out with two data storage computers with STEC’s drives about six months ago.

“The introduction of those two products has caused this market fruition to come around,” Mobley said. “EMC is now STEC’s largest customer and it’s driving tremendous revenue momentum for STEC.”

STEC is likely to see more sales growth as IBM rolls out its own line of products built around STEC’s drives.

EMC has roughly 15% of the market for computers on data storage networks. IBM has about twice that.

“IBM will be a big catalyst for STEC,” Mobley said.


Competition

Competition looms for STEC.

A few big players have entered the fray in the past year, including Western Digital and Fountain Valley-based Kingston Technology Co., a maker of computer memory products.

Seagate said earlier this month that it’s set to roll out its own solid state drives at the end of 2010.

Other potential competition comes from big chipmakers, including Intel Corp., Marvell Technology Group Ltd. and Samsung Group.

“They have experience with controller chips and at some point will be able to crack the loop,” analyst Schreiner said. “There isn’t going to be any real competition for the remainder of this year, so any demand out there in the market is likely going to be met by STEC.”

STEC is taking away one of the last areas of good profits for Western Digital and other disk drive makers. But Western Digital appears to be holding up.

The company’s shares are among the strongest here this year, in part because of the company’s adept handling of the slowdown by managing production and stockpiles of drives.

And while STEC is a threat to a profitable part of Western Digital’s business, it isn’t likely to take all of the market for drives in servers and data storage computers.

Operators of data storage networks are likely to keep using a mixture of drives for a while, including STEC’s pricier solid state drives and less expensive ones from Western Digital and others.

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