First Montauk Issues Investment Opinion on Iomega.

NEW YORK--(BUSINESS WIRE)--Feb. 17, 1999--First Montauk Securities Corp. initiating coverage of Iomega Corporation (NYSE: IOM) effective 2/17/99.

Initial Coverage
2/17/99
Rating:
Short term:  Buy (2)
Long term:  Strong Buy (1)
Risk:  Speculative

Shares outstanding 267,234,000
Price as of 2/17/99 $6 3/8
Market Capitalization $1.70 Billion
52-wk range $2 15/16 to $10 3/16
Book Value $1.56
Dividend nil
Yield nil

     Earnings      Q1         Q2          Q3          Q4        FYE'99
     Projected    .02        .06         .08         .12           .28

                    1995     1996      1997      1998           1999E
     Sales         0.326B   1.212B    1.740B    1.694B          2.200B
     EPS             .03      .21       .42      (.20)            .28
Projected 5 year CAGR- 35%

Overview

Iomega is a major player in the removable computer data storage market. They have 4 current platforms (Zip, Clik!, Jaz, and Ditto) that provide both businesses and consumers the ability to organize, transport, and store data for the digital age. Zip is their flagship product and it has been adopted as fast as any other product in consumer electronic history. Designed to replace the 1.44 MB floppy drive, Zip is on the verge of achieving that goal. The risk/reward proposition of Zip alone is enough to justify the current price of Iomega's stock. Additionally, Iomega has new products currently rolling out that could substantially enhance the value of the stock as well as increase their dominant position.

The Products-Zip, Jaz, Clik!, Ditto

Zip is a low-end magnetic storage solution that is intended for the floppy replacement market. Zip disks hold 100 MBs of data (70X the existing floppy) on the original, and 250 MBs of data (175X the existing floppy) on the new and improved version. Iomega has shipped over 21 million drives to date and approximately 150 million disks (10 Billion floppy equivalents). They were initially targeted at the hard drive extension market and the heavy power-user market of the graphics industry. Zip is now making a transition into the mainstream, and will be increasingly used more for organization and transport of data, as well as raw storage of data. The company has undergone a transition in 1998 to position it to be able to supply OEM manufacturers with volume delivery at much lower prices. The basic strategic significance of this platform is a razor/razor blade business model that, if successful, could mean an ever-expanding revenue and profit stream in the future.

Jaz is a high-end magnetic storage solution that is intended for the heavy-duty power-user market. Jaz disks hold 1GB and 2GBs of data and are currently the best removable product on the market for professionals. In addition to holding the most capacity, they are almost as fast as a hard drive. This makes them the preferred solution for graphic artists, movie production, large engineering projects etc....Jaz has this market almost entirely to themselves because Syquest, their only true competitor, filed for bankruptcy late last year. (in fact Syquest was recently bought by Iomega) The basic strategic significance of this platform is two-fold. First, it fills the high-end market niche with Iomega's own products, which can be leveraged to protect significant intrusions into the Zip market by competition. And second, to a lessor extent it also has a razor/razor blade model that has the potential to produce significant profitability when not being used to stop aggressive competition (see issues).

Clik! is the smallest magnetic storage solution on the market today. It is Iomega's answer to the expected growth in the miniaturized use of computers. Everything from cameras to MP3 music players to gameboys is going to explode storage needs in the next few years. Iomega developed a low-cost solution to fill this potentially huge market. Clik! has recently started shipping (December 1998) and while it is too early to tell how it will be received, early indications look promising. The basic strategic significance of this platform is also a razor/razor blade business model. Iomega hopes to leverage its success with Zip and Jaz into another platform that has as much (if not more) potential to produce future profit and revenues streams.

Ditto is a tape product aimed at the personal and small business user for primarily backup purposes. Tape use is declining due to the success of Zip and Jaz providing the same functions faster. While Iomega mind its stock.

The Issues

The first issutly 6 major ways to store that information: fixel different technologies will co-exist. The basoducts are very important for organization, porthis problem. Many different companies make the has carefully sought out the proprietary part ofdrives and should add another 15+ million in 1999. Their installed base of existing customers now buy more disks than new drive purchasers buy. This means they can use the high-margin disk sales as a weapon to fight any new entrants by subsidizing drive costs (a benefit that should not be taken lightly). Eventually a floppy-replacement product will reach a point of inevitability and the competition will either go away or enter specialized niches. Zip is by far the leader and the odds on favorite to be that product. And with the recent introduction of the 250 MB drive (175X current floppy), they are positioned to be technologically superior for many years to come.

Jaz is a volatile, but important part of Iomega. Because it is the fastest and larse users from defecting to a rival's product. An example of this protection can be seen in the recent bankruptcy of Syquest. Syquest tried to position SparQ 1 GB as a 'Z-end protection for the cost/MB argument, taking away the issue from any future Zip competition.

Jaz currently has no competition and should actually be quite profi2+ years) this product will be replaced by something faster and bigger as technology improves.

Clik! is too early to comment on at length. However it's developments deals with Olympus and Compaq. There is no douso, Clik! could be bigger than Zip, but again it is too early to tell at this point.

The Risks/ The Competition

The biggest risk to Iomega is that someone develothe OEMs (and going lower), and very few of thes wouldn't have. However, several factors could be combined to invent a negative scenario. For instance, if a marginally better product in terms of speed and size were combined with a deep-pocketed competitor willing to lose $100 million+ to gain instant entry, then Zip would have a formidable fight.

The next biggest risk to Iomega is their own performance. Slow product delivery, defective products, poor customer service, general corporate arrogance, etc....would be items that could provide a window for competition to climb through. While Iomega has made very important appointments in top management in the last 12 months, it is by no means a certainty that they won't have to go through more shakeups.

Capitalization is a somewhat relevant risk when weighed against future growth and competition. Iomega is a $1.7 Billion company but is attempting to grow to $10 Billion. If successful, they would strain existing resources. Inventory management is very important and the company hired Scott Flaig to implement the 'Build-to-order' operational management system that he pioneered at Dell. Any loss of key personnel in this area could dramatically hinder Iomega's ability to capture the opportunity before them.

Return to profitability is also very important and the failure to do so could seriously impair Iomega's ability to fend off rivals. Overall R&D spending is still low compared to the large cap technology stocks and should be increased over time to strengthen future product offerings. Advertising spending has been cut back dramatically and will need to be increased in the future. Any setbacks on the profitability side could hinder brand building that is crucial to Iomega in the long run.

Current competition is actually fading fast, but 3 identifiable competitors in the magnetic area can be discussed. The only one of them with a current competing product is Imation. Imation makes the LS-120 or Superdisk, which competes, in the Zip market. It is a 120 MB magnetic disk which also is backward compatible to the 1.44 MB floppy. They have been on the market almost as long as Zip and have had lukewarm reception. They have an installed base of a reported 4 million drives, and have announced 'intentions' to double that installed base by the end of 1999. They have gained a few recent wins in the OEM market (Compaq and NEC), however they have to 'seed' these drives by subsidization in hopes to gain a foothold by 2nd half of 1999. They recently sold a large division to Kodak, so they are flush with cash, but they appear to be carving out a niche for themselves rather than going after Zip directly.

The larger and possibly tougher competition could be Sony. Sony has announced, shipped, recalled, and now is reportedly going to re-ship the HiFD 200 MB magnetic disk drive. This drive would also be able to read the 1.44 MB floppy disk, and on paper is the closest competition for Zip. It is much faster than the LS-120, higher capacity, and would have a brand-name recognition with the consumer that Imation doesn't have. If it does ship, expect one of the two products (LS-120 or HiFD) to drop out within a year. Sony stated they are going to re-release the product this quarter, but the product was originally due in Spring of 1998. Iomega answered the introduction of y and they are reported to be producing a 2.2 MB Jaz-like product that would compete mainly on price. Similarking about competition at this point could include just about any storage product and method of transferringther, with this success, the predictability of the earnings improve and 'analysts' are more comfortable looking farther out in time. This leads to a phenomenon that causes the Multiple to rise in addition to the actual earnings rising. This can cause very explosive upside moves, and ae than total units as IOM finishes their transition into OEM units on the drive side. On the disk side, Iomega will use the price/elasticity curve to realize very signifing disk sales compensate for what pricing actions are taken. Clik! and Ditto will be a net overall positivea Price/Sales basis IOM is trading at 0.78X our 1999 estimate of $2.2 Billion in Revenues.

3) Predictability of Earnings- Confidence in management's ability to deliir credibility. Look for this part of the multiple equation to increase or decrease directly based on each quarters performance with respect to consensus. Weighing all tng (2). I believe that IOM at this time will trade between 20X current year earnings on the low side and 40Xmentum' investors and is the primary reason why it is so highly adopted in the investment community. However, when proprietary market wars are fought, the actual results should be measured in ways that are not necessarily directly related to current earnings and sales growth. Barrier to entry is very important, in fact issues such as strategic alliances, marketing channels, installed base, product virtues, etc.... are far more valuable in the long run.

The alternatpoly status.

As it relates to Zip:

A) What would the value of IOM be if Zip WERE the replacement for the floppy? What would be the cash flow per year from disk sales (similar to MSFT model)? What would the leadership position in the industry allow them to 'control' as it pertains to new products and upgrades of existing products (similar to INTC model)?

Several assumptions must be made when valuing the floppy replacement market winner. Probably the most important is the idea that there will be only 1 format commonly used to transfer, organize, and backup data between computers, set-top boxes, printers, scanners, etc.... Another significant assumption is that there will be little profit in the hardware manufacturing (except for the short upgrade cycles), and most of the profit will be achieved through disk sales.

Zip penetrated (at the OEM level) 7.5% of all PC's sold worldwide in Q4 1998. The floppy replacement winner should attain roughly 70% of the PC market. Total removable drive sales double from PC-only sales in the future as new non-PC devices such as scanners, printers, and set-top boxes add removable storage.

Prices of the disks will fall and units sold will explode. Initial success of the high capacity removable was driven by a cost/MB need. Future disk consumption will be driven by the relatively low cost/unit of organizing and transporting data. As the world becomes increasingly more digital, removable storage disks will replace filing cabinets and photo albums for organization. In addition, sharing and transport of data between different devices, family members, and home-to-office will all be accomplished in a common format.

Zip disks alone accounted for at least $400 million in total high-capacity removable disk sales in 1998. When competition is added, $500 million would be a realistic number. It is not hard to envision 10X that number or $5 Billion as a future yearly requirement. Assuming operating margins drop to a conservatively low 30% on these disk sales, the cash generated by this monopoly (on disk sales alone) would be $1.5 Billion per year.

In addition, the leadership role that the winner in the 'floppy war' will have will also be quite valuable. Similar to Intel in the chip market, the leverage that could be applied over future formats could build another dynasty. (Digital film is one example) While the hardware manufactured will be low margin, each upgrade of capacity and compatibility would be higher margin. In addition, licensing revenues from other drive manufacturers could also become significant.

The actual value of the winner is very volatile and subject to individual interpretation. Our assessment is that the company that attains this status would be worth at least $30 Billion. For comparison of other near-monopoly or proprietary computer companies:

MSFT $375 Billion, INTC $210 Billion, AOL $72 Billion, AMZN $16 Billion.

B) What are the chances of success?

Zip has 21 million up has locked up the 'early adopters' and 'power returned to profitability in Q4, they will neeercome before Zip is clearly the winner in the floppy replacement race. However, at $6.375 per share ($1.70 Billion market cap) the market is either a) misjudging the value of the ultimately victorious company, or b) grossly under-estimating Iomega's chances. In handicapper's terms, IOM at the moment is given about a 16 to 1 shot to replace the floppy. Our assessment is that Zip has roughly a 5 to 1 shot in the current environment.

Our conclusion based on the alternative valuation model is that the market value for the final 'floppy replacement product' should be $30 Billion, and Iomega's chance of Zip becoming that product is 5 to 1. Therefore, a long-term holder looking at a fair risk/reward ratio would be willing to pay up to $5 Billion (or $18 per share) for IOM right now. At $6.375 per share, the stock is a very compelling opportunity.

This communication reflects our opinion as to the securities mentioned herein, but is neither an offer to sell them nor a solicitation of an offer to buy or sell them. Any recommendation contained in this report may not be suitable for all investors. Moreover, although the information contained herein has been obtained from sources believed to be reliable, its accuracy and completeness cannot be guaranteed. First Montauk Securities Corp. may make markets or have positions in the securities mentioned herein (or options with respect thereto) and may have performed investment banking services for the issuers of such securities. In addition, employees of First Montauk Securities Corp. may have positions and effect transactions in the securities or options of the issuers mentioned herein and may serve as directors of such issuers. Copyright 1999. All rights reserved by First Montauk Securities Corp. Member NASD/SIPC.