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Momentum

Shares of Datalink Corporation (DTLK) are up 8.7% since this Zacks #1 Rank (Strong Buy) reported first quarter results on April 25. We believe there is further upside for this provider of data center infrastructure solutions and services, given its focus on an extremely fast-growing market segment.

Q1 Revenue Soars 39%

Because of the nature of its business, we do not think that DTLK’s prospects should be judged from a single quarter’s performance. However, recent results have been very strong.

While both products and services revenues were up by double-digits, product revenue growth was stronger, driven by networking and servers (up 147.1%). Midwave (acquired in October last year) was clearly the reason, as it doubled the revenue generated from Cisco.

Storage and software are also both doing well, as evidenced from the year-over-year revenue increases of 29.5% and 94.6%, respectively. This basically reflects market trends, where most vendors are increasing focus on software (because of its higher margins) and on storage (because of its huge demand due to cloud computing).

Compare this with the revenue growth seen by hardware vendors Hewlett Packard (down 7.0%) and Dell (up 2.2%), storage provider EMC (up 10.6%), networking products provider Cisco (up 6.6%) or services and software provider IBM (up 0.3%).

Datalink’s superior performance is because it sells intelligence, a particular niche that drives sales for all these players by helping clients make decisions. We expect vendors to increasingly rely on service providers, such as Datalink, and buyers to increasingly opt for a one-stop shop that could optimize their IT infrastructure and facilitate their move to the cloud. We believe this will drive tremendous growth for the company over the next few years.

The solid top line story notwithstanding, first quarter earnings were just in line with the Zacks Consensus Estimate of 14 cents because of a slightly negative mix of products and management’s decision to invest in infrastructure and human resources. We can’t fault the strategy, since Datalink continues to see very strong growth (revenue was up 64.9% and 29.4% in 2010 and 2011, respectively).

Q3 Guidance is Huge

Datalink expects revenue to be up 45.3% year over year (at the mid-point) and earnings of 17 cents at the mid-point (down a penny from last year). The revenue growth reflects strong demand, while the earnings reflect increased investment in the business (typical of a company seeing very strong growth).

Datalink is Undervalued

Despite its solid growth profile, shares appear undervalued. At 17.91X P/E, 0.46 PEG and 0.47 P/S, it is trading at a discount to the peer group in every respect.

Add to this its earnings growth potential of 22.5%, which exceeds that of the storage, software, networking and computing industries, and we think the shares are worth buying.

Company Profile

Datalink enables the setting up and smooth functioning of data centers by analyzing the requirements of mid-size and large organizations, designing a suitable system for them and then helping them to set up such a system with minimal disruption in existing work flows. The company also offers disaster recovery solutions and services.

For this purpose, Datalink works with servers, storage products, security products and networking products (routers, switches and so forth), which it sources from companies like EMC Corp (EMC), NetApp (NTAP), Oracle Systems (ORCL), Dell (DELL), Symantec Corp (SYMC), VMware (VMW), Cisco Systems (CSCO) and Brocade Communications (BRCM). Datalink does not manufacture any products of its own, but designs the appropriate combination of products from these suppliers to optimize the system for its clients’ requirements.

Chanhassen, Minnesota-based Datalink employs 389 people, including 165 engineers at its headquarters and 29 field sales offices across the U.S.

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