Is IBM To Blame For This Company's Weak Sales?

Last night, NetApp reported lower than expected revenue for its fiscal fourth quarter. Who's to blame for the miss? According to NetApp, fingers are pointing at Dow component IBM.

May 22, 2014 at 1:00PM
Take The Long View

The Dow Jones Industrial Average (DJINDICES:^DJI) traded slightly higher in early afternoon trading, in what has been an up and down week.

Dow component IBM (NYSE:IBM) was in the headlines Thursday morning as a scapegoat for weak revenue at data storage and management company NetApp (NASDAQ:NTAP).

What the what?
Last night after the closing bell, NetApp reported results for its fiscal fourth quarter. The company beat estimates for earnings, posting non-generally accepted accounting principles results of $0.84 per share, but missed on revenue expectations. 

The company forecast fiscal 2015 revenue to decline 3% year over year, but it expects to grow earnings by 4%. NetApp's stock has had a tough run over the past three months, and investors responded to the higher than expected earnings by bouncing the stock up nearly 4% higher in Thursday trading.

NTAP Chart

NTAP data by YCharts.

Why are investors largely ignoring the miss on the top line? Partly due to much improved earnings, but it may also be because NetApp has someone to blame for the miss: IBM.

Branded versus OEM revenue
To understand how IBM fits into the picture, we have to drill down a bit into NetApp's revenue model.

The company builds and sells database management solutions -- their servers house and manage the extremely complex big data needs for largest enterprises around the world (for example, the U.S. military). 

Netapp Logo

Source: Company website

NetApp sells these solutions under its own brand name, but also allows third parties to buy NetApp goods in bulk, slap on their own logo, and then sell the product as the "original equipment manufacturer."

In the company's fourth quarter, the branded business -- in which NetApp sells its own products directly to the end user -- did quite well. Branded revenue was up 6% quarter over quarter driven by strong sales of the company's ONTAP next-generation cloud storage solution. According to CFO Nick Noviello in an interview with Barron's, the company will raise its internal expectations for growth in this sales channel. 

Meanwhile, revenue on the OEM side of the company declined 30% quarter over quarter, and 34% year over year. This decline is made even more significant by the fact that indirect revenue makes up nearly 85% of the company's total revenue.

NetApp's largest OEM partner? IBM, of course.

Ibm Logo

IBM's logo from 1924-1946.

Noviello said, "You have to look at the overall landscape of IT, and what some partners are dealing with. Our largest OEM partner who people know of is IBM. Take a look at their earnings and you can draw your own conclusions."

IBM's revenue issues have been well documented. The company is moving away from low-margin hardware businesses and toward higher-margin service and software opportunities. 

The trend is representative of a shift across the entire enterprise information technology space. Dell went through a very public proxy battle last year to take the company off the public markets. Why? So that management could attempt the same transformation from hardware to software and services.

CEO Tom Georgens stated on the NetApp earnings call that the company has been expecting this decline in OEM, and that's why the emphasis has been on growing the branded business. On the surface this may seem to allay investor concerns. But given that it makes up the great majority of total revenue, the transition from OEM to branded could get ugly in the interim. 

To blame IBM ignores the long-term trend
Analysts this morning pointed to NetApp's cost management and increased dividend and share buyback program as reasons to be bullish on the stock. The company's margins are impressive, and it will almost certainly continue to generate strong cash flow to fund more dividends and more buybacks.

Netapp Server

NetApp Branded Servers Source: Paul Hammond

Piper Jaffray assigned an overweight rating after the earnings call, with a target price of $39. Brean Capital recommended the stock as a buy, also with a $39 price target. 

That's all well and good from a financial standpoint, but what about the business fundamentals? On the earnings call last night, CFO Noviello projected middle single-digit branded revenue growth in fiscal 2015, which could be more than offset by declines in OEM revenue of potentially 40%. 

Citigroup also assigned a $39 price target, but this represents a reduction of $4 from its previous expectation. The analyst noted the revenue problems and remained neutral on the stock. I tend to agree more with Citi than with Piper or Brean.

Cost savings and financial engineering can only go so far to buoy a stock. I'm much more interested in companies with the strongest business fundamentals and even better valuations. NetApp is trading at about 20 times earnings; for a company playing the blame game to account for its negative growth, that price strikes me as being a bit expensive. 

If you're looking for value, NetApp at best remains a wait and see.

Are you ready to profit from this $14.4 trillion revolution?
Let's face it, every investor wants to get in on revolutionary ideas before they hit it big. Like buying PC-maker Dell in the late 1980s, before the consumer computing boom. Or purchasing stock in e-commerce pioneer in the late 1990s, when it was nothing more than an upstart online bookstore. The problem is, most investors don't understand the key to investing in hyper-growth markets. The real trick is to find a small-cap "pure-play" and then watch as it grows in EXPLOSIVE lockstep with its industry. Our expert team of equity analysts has identified one stock that's poised to produce rocket-ship returns with the next $14.4 TRILLION industry. Click here to get the full story in this eye-opening report.

Jay Jenkins has no position in any stocks mentioned. The Motley Fool owns shares of International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information