AI Archiving Backlog And Debt Overhang Will Eventually Reward Patient Outlook

Catalysts

About Quantum

Quantum provides data storage and management solutions, including tape libraries, object storage and software for long term archiving and backup.

What are the underlying business or industry changes driving this perspective?

• Although Quantum is seeing interest in hyperscale archiving projects such as the Library of Congress 100 year archive and a record product backlog of over US$25 million, manufacturing constraints in tape libraries and an incomplete transition to Avnet limit how quickly these orders can be converted to recognized revenue and cash flow.
• While demand for ActiveScale object storage and Scalar i7 RAPTOR aligns with growing needs for long term data preservation and power efficient high density storage, tight supply conditions and a complex set of hardware platforms and SKUs are pressuring product gross margins and could slow any improvement in overall earnings quality.
• Although Quantum is targeting AI and high performance computing workloads through its partnership with Entanglement and positions its storage as a fabric for AI data centers, the company still carries about US$6 million of quarterly interest expense and relies on shareholder approval of a US$52 million debt exchange, so any delay in AI related deployments could prolong pressure on net income.
• While the move to tiered, cyber resilient storage for AI data lakes and long term archives supports potential multi year customer spending patterns, Quantum is early in reshaping its product road map under a new Chief Product Officer and any missteps in prioritizing StorNext, DXi and ActiveScale could dilute the impact on future revenue and operating margins.
• Although cost reductions have brought non GAAP operating expenses down to US$24.8 million and contributed to positive adjusted EBITDA of US$0.5 million, the company is still reporting GAAP net losses, and warrant related fair value swings linked to the stock price introduce ongoing earnings volatility that may weigh on reported EPS.

Assumptions

This narrative explores a more pessimistic perspective on Quantum compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Quantum's revenue will grow by 2.2% annually over the next 3 years.
• The bearish analysts are not forecasting that Quantum will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Quantum's profit margin will increase from -57.1% to the average US Tech industry of 6.2% in 3 years.
• If Quantum's profit margin were to converge on the industry average, you could expect earnings to reach $17.1 million (and earnings per share of $1.02) by about January 2029, up from $-146.7 million today.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 12.1x on those 2029 earnings, up from -0.7x today. This future PE is lower than the current PE for the US Tech industry at 24.7x.
• The bearish analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.98%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Quantum is still reporting GAAP net losses, with a GAAP net loss of $46.5 million in the latest quarter and ongoing quarterly interest expense of about $6 million, so any slowdown in cost savings or revenue growth could keep net margins weak and delay the path toward positive earnings.
• The business carries a product backlog of over $25 million but faces manufacturing constraints in tape libraries and an incomplete transition to Avnet, so if supply chain tightness persists, the company may struggle to convert orders into recognized revenue and cash flows in a timely way.
• The plan to convert approximately $52 million of term debt into senior secured convertible notes still relies on shareholder approval, so if this does not go through, the company could remain highly leveraged for longer, keeping interest expense elevated and pressuring net income and cash on hand.
• Gross margin trends remain mixed, with GAAP gross margin at 37.6% compared to 42.7% in the prior year second quarter and product margins affected by too many hardware platforms, tight component supply and rising input costs, which together could limit any improvement in overall profitability and operating margins.
• Quantum is repositioning around AI, high performance computing and large archive projects. However, these are long cycle markets, and any delay in customer deployments or slower than expected uptake of solutions like ActiveScale and Scalar i7 RAPTOR could leave revenue growth below expectations and weigh on future earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Quantum is $9.0, which represents up to two standard deviations below the consensus price target of $11.0. This valuation is based on what can be assumed as the expectations of Quantum's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $13.0, and the most bearish reporting a price target of just $9.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $274.1 million, earnings will come to $17.1 million, and it would be trading on a PE ratio of 12.1x, assuming you use a discount rate of 11.0%.
  
• Given the current share price of $7.73, the analyst price target of $9.0 is 14.1% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.