Imation Corp. (IMN)

Imation is a removable data storage media company the market has oversold due to an overreaction to unfavorable industry trends. Imation’s problem and the cause of the selling pressure is two-fold; Imation’s primary and highest margin products are proprietary and semi-proprietary magnetic tape products and the market for these products is slowly deteriorating due to the emergence of new storage formats. Secondly, although demand for data storage is dramatically increasing each year, removable media market size is expected to decline in terms of revenue. One reason for this is open format tape, or non-proprietary tape, continues to gain share against the proprietary legacy formats owned by companies like Imation. The result of this trend is fewer units will be shipped because the new non-proprietary storage formats have higher capacity cartridges, are typically more competitive with lower gross margins, and lead to greater price competition. So despite increased storage demand, revenues will likely decline.

Obviously these are unfavorable industry trends. However, Imation has a viable business model and is transforming their product mix. They are reducing their reliance on the only product they manufacture themselves, magnetic tape for data storage, and expanding their product offerings in optical, flash, and removable HDD. For a sense of the growth opportunity, the magnetic tape business is estimated to be a $1.8B industry, while the optical and flash media industries are estimated to be $3B and $11B, respectively, and removable HDD is still an emerging industry. I think this business is worth something, but the current valuation implies the product lines have almost zero value.

Imation trades at a 22% FCF yield on 2008 numbers and has consistently generated strong free cash flow for the past 10 years. On TTM it trades at a 15% FCF yield and EV/EBITDA is 2.6x using 2008 numbers. Even if EBITDA is cut in half, it will trade at only 5.2x EBITDA. They also have a very strong balance sheet and even when I am extremely conservative, I calculate a liquidation value of roughly $8.00 a share.

The average street estimates imply Imation will do $1.9B in sales in 2009 and $2.2B in sales in 2010. EBITDA margins peaked in 2002 at 13% and in 2008 they hit an all time low of 3.9%. My worst-case scenario estimate for 2009 leads me to believe the stock is too cheap to ignore.

Downside Scenario
-   Revenues come in at roughly $1.5B, or 20% below the lowest street estimate out there of $1.87B.
-   Margins decline to all time lows of 3%.
-   2009 EBITDA is roughly $45mm (3% EBITDA margin on $1.5B)
-   End 2009 with EV/EBITDA multiple of roughly 5x.


That's cheap.