Rimage: The Disc is Not Dead - Yet

Here’s an object lesson in how stocks with thin trading volume can get hammered.

On Monday, Rimage Corporation (RIMG) reduced 2nd quarter guidance, citing the economic slowdown. Revenue expectations dropped from $24-26M to a new target of $20-22M. Earnings projections plummeted, to 9 to 12 cents per share, from previous guidance of 22-27 cents. Analysts estimates were–predictably–within the previous guidance ranges.

Rimage (pronounced like the French, i.e. “rim-AHZH”) makes high-capacity disc publishing systems that replicate CDs and DVDs as well as customize discs and print/apply labels.

It also does a high-margin business selling blank discs and labels.

If you’ve ever ordered a custom-mix CD from Wal Mart (WMT) , it was printed on one of Rimage’s units.

While Rimage sells its publishing systems into the media industry for music, movie, and software storage, it does a substantial amount of business with large enterprises that create custom discs for product promotion or employee training purposes. It also sells to data-intensive industries needing quick, simple records storage. In particular, the medical industry is one of Rimage’s most important end markets.

I never wrote on Rimage as an analyst, but I do keep it on my radar screen, as its business model not only ties into Digital Media but also fits a theme I’d developed on creating value at the edge of markets (in this case, disc replication).

However its trading volume, averaging about 77M shares daily, is less than 1% of the float.

This makes for a very illiquid stock, especially one that until Monday was at a market cap of $170M. Which is the biggest reason it’s covered by only 2 analysts.

As you might expect, Monday the stock dropped a hefty 22%. I’m convinced a good piece of that was due to a lack of buyers for an undercovered, thinly traded name. But many pundits will claim a major reason is that Rimage’s business model is dead. After all, we’re in the iPod generation, discs are passe. With high speed broadband everywhere, and ubiquitous media players, nobody needs plastic anymore.

Bzzzt! Wrong answer.

Sure, any company that reduces guidance so much, particularly one that’s so thinly traded, is going to get a serious haircut on its stock price. And I do believe that eventually, all data storage will be on drives, and delivery will be via broadband. But the key word is eventually.

Recall Amara’s Law (often erroneously attributed to forecaster Paul Saffo): “We tend to overestimate the short-term impact of technological change and underestimate its long-term impact.” As much as we think broadband has already taken over, we forget that not everyone has fiber to the home, nor have they all junked their CDs for a portable mp3 player. The iPod has not reached 100% penetration. Netflix still expects to be renting DVDs for some time. Hell, 20% of Americans have never even sent an email. Not to mention the fact that there are numerous other applications for discs besides personal entertainment media.

These transitions always take longer than we think. Expect discs of some type to be with us for at least another 10 years.

Even at less than half its recent earnings growth rate (8% vs. a 2-year CAGR of 17.4%), Rimage has a PEG ratio hovering around 1.0, based on trailing twelve month earnings. And with a solid cash flow (price-to-FCF ratio is about 7), it’s likely to be able to milk that disc market for some time to come. Perhaps not a value play, but certainly not overvalued either.

Just watch that trading volume and liquidity. Yes, an upside surprise can really rock a thinly traded name like Rimage. But risk management is the name of the game, and you don’t want to be the last one out of the exits if the bottom falls out.

Disclosure: I hold no position in any of the stocks mentioned here.

Comments

[searchingforvalue]

Don't forget the balance sheet....

Rimage is DEBT FREE and has over $9 per share in cash along with a hefty active stock Buyback in place.

At $12.50 you are buying their entire business for only $3.50 per share (or $35 million!) At the current earnings estimate of .80c in 2008, it means you are only paying 4x earnings for their business which generated $4.81 in earnings over the past 4 years. Sounds like an intriguing Value with limited downside from here.

[TheHappyCamper]

A very important thing to mention is the ability of Rimage to adapt their knowledge and technology into new emerging markets: archiving, broadcast, security, etc. Rimage has very powerful XML based multi-platform engine for data delivery, publishing, archiving and replication that can be used for many other purposes besides disc publishing. There is a lot they can do with all that cash they have and their nice technology. Ask companies like Epson that are trying to follow Rimage, or companies like Xerox that are trying to license their technology...