Trade Denied – NTAP: Elliott Waves Bye Bye

by Enis May 19, 2014 11:47 am • Commentary

We laid out the bull case on NTAP in a Name That Trade post about a month ago:

NTAP’s cheap valuation is essentially an argument between bulls who think those projections are reasonable, and bears who see a more significant business drop off in the next couple of years.  For now, my odds would be on the bulls, mainly since NTAP’s valuation metrics have reached historically cheap levels, which also explains the extensive activism on the part of investors like Elliott.

Here is the 10 year chart of EV/EBITDA for NTAP:

NTAP Enterprise Value / Earnings Before Interest, Tax, Depreciation, and Amortization (EV/EBITDA), Courtesy of Bloomberg

The stock has bottomed in the 5-6 area on a couple occasions in the past decade.  Few businesses that expect long-term earnings growth trade below a 5x EV/EBITDA.

NTAP reports earnings in late May.  Until then, no major catalyst exists for the stock.  This is the type of situation where the cheap valuation and the activist investor involvement likely provides support on the downside, while the recent downtrend suggests ready sellers on any bounce.

Rather, we’ll keep this stock on our radar if it makes a move lower in the coming weeks towards the longer-term support level near $32.50 (green below):

NTAP weekly chart, Courtesy of Bloomberg

At that level, the risk/reward would be very favorably skewed in favor of the long side.  Whether that would mean we would simply buy the stock for the investment portfolio or put on an options structure would be determined by the nature of the selloff, options pricing, and the upcoming catalysts.  But we wanted to lay out our thoughts so that we can quickly pull the trigger if and when the time comes.

NTAP reports earnings on May 21st after the close.  The stock has closed down on each of the last 3 earnings reports. On its February earnings, NTAP management lowered guidance to a level that it designated as appropriately conservative, so market participants clearly view the current bar as lower than normal.  The weak network storage spending environment and increasing competition has dissuaded technology investors who generally prefer growth stories over value situations.  

Last week, when I revisited the NTAP situation, my first inclination ahead of the earnings event was to look for a mildly bullish options structure.  The company has been in a tough slog (as shown by recent earnings reports), but Elliott Management’s activist stake and the cheap valuation were both factors likely to offer downside support on a weak earnings result.

However, on Thursday’s 13-F filings from hedge funds, Elliott’s filing indicated that it had sold out of NTAP. Given that Elliott has been quite vocal about instigating changes over the past year, their exit has us concerned about the direction of NTAP’s business and overall business prospects.

While we don’t base our positions only on other investors, we do place more importance on clues from the big activist players in the market (see EBAY activism).  Elliott’s exit has made the risk/reward of a mildly bullish options structure in NTAP ahead of earnings less appealing to us for now.