Iomega Bull's Pen
by Pat Keeler (TMF Keeler)

Since the first PCs were sold, they came with affordable rewritable removable storage. The first PCs used common cassette tape recorders, but poor quality and non-random access doomed them, and they were quickly replaced by the first disk-based products. With affordable, easy to use floppy disks, computer users could back up their work, swap software with other PCs, and archive files.

Computing has come a long way in over a decade, but the floppy disk drive has evolved very little. Then in 1995 a small "turnaround" company called Iomega introduced the Zip drive. The consumer rediscovered how much utility there was in affordable rewritable removable storage when presented with a system that was worthy of the computing environment of the time. Zip drive sales took off, and so did Iomega's financial performance.

Eleven months later the company arguably owned the non-floppy removable storage market and, more importantly, had expanded that market far beyond what it had been. Iomega grew its sales from $140 million to $1,200 million, faster than any tech company in history. I don't know if the Zip drive will replace the floppy, but I do know that it gives computer users the functionality and storage capacity they have always needed.

Zip, Zip, Zip, blah, blah, yada, yada. I'm not even sure why I bother discussing the story, we all know it. The fact is, at a recent price of $10 a share, I don't even need to sell the Iomega story. I don't have to mention its second disk product, Jaz, being only the second non-floppy removable drive to sell over a million units (Zip being first -- of course). I don't have to even ponder the new micro-sized zip-like Clik! drive for hand-held electronic devices like personal digital assistants (PDAs) and digital cameras. This is not a momentum stock looking for rationalization, this stock is at all-time low valuations following a quarter and fiscal year where it had reported record revenues and earnings.

Iomega just completed its third fiscal year since the Zip drive was introduced. The stock recently dropped because Iomega missed earnings estimates for the fourth quarter of 1997. Even though it missed estimates, the fundamental numbers continued to rack up. More than 8 million Zip drives were sold in 1997 vs. 4.3 million over the previous two years combined. Of those 8 million drives, around 2 to 2.5 million of them were sold pre-installed in computers (i.e. sold by OEMs). A million OEM Zip drives shipped in the fourth quarter alone. In fact, you can now discuss Zip OEM sales in percentage terms! Domestically, roughly 10% of the PCs sold in the fourth quarter had a Zip drive built-in.

Iomega's PE ratio is 24. That is the multiple on trailing, fully diluted earnings. Not the forward PE. Not the PE given when rationalizing fast growth stocks with high trailing PEs. This PE is basically a market multiple; in other words, a PE on par with what the S&P 500 carries (in fact, just a few points above). But did the S&P 500 grow earnings per share over 100% over the last 12 months? Give me a break. I'd be interested to know if any of the 500 companies in the S&P 500 grew earnings 100% over the last 12 months.

Iomega has an enterprise value-to-sales ratio of 1.2. It has not been valued so cheaply in the 3 years that I've followed it. Revenues in fiscal 1997 grew 42% and gross margins improved to 33.4% from 28.6%.

A good Fool does not take such numbers at face value without wondering why such a great company is given such a low valuation. I'm sure you can next read Pauly's account of doom and gloom to get an idea. However, I have my own thoughts on the subject. What's on my mind? The lingering effect of a shortage last summer of a certain critical semiconductor used to make Zip drives. Iomega has always had a problem, from time to time, convincing its suppliers that it really needs millions of a component. During the shortage, Iomega committed to supplying Zip drives to the OEM market while eschewing the retail market. OEM drive customers tend to buy fewer disks in the 6 months following purchase than do retail Zip drive buyers. Makes sense, they have less of an immediate need than someone buying a drive at retail. Well the shortage threw off the mix of retail and OEM drives over the summer, and that resulted in lower disk sales last quarter. That caught Iomega off guard and left it a penny or two short of estimates.

The shortage ended in September and should have no further impact beyond this present quarter. A Fool looking out a couple of years will see an opportunity in a company with an average PE that is growing earnings and revenues much faster than average.

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