The future looks uncertain for storage systems provider NetApp (NASDAQ:NTAP), with decreasing sales and slowing demand in its core market. Lying behind this are worrying long-term trends, such as tight IT budgets and the rising popularity of cloud services like Amazon.com's (NASDAQ:AMZN) AWS. But, NetApp has been around for a while, and it's adapted successfully to industry shifts before. Can it do so again, in spite of its current, unenviable position?
Why is NetApp in trouble?
NetApp is still making quite a bit of money, and thanks to a restructuring last year, its EPS is up significantly from a year ago. However, revenue was down 4% from the same quarter last year, and the company faces general concerns over its ability to grow.
NetApp has a sizable business with the federal government, and it has been hit hard by the ongoing budget sequestration. It also sells its products to OEMs, but that line of business is shrinking as well, with a 34% year-over-year decline in revenue in the most recent quarter. In particular, IBM, one of NetApp's largest OEM customers, recently announced that it will no longer sell NetApp products in favor of its own storage devices.
The remaining and major part of NetApp's business is its own branded products. This segment is also not doing brilliantly, with flat sales compared to a year ago. Management explained that they are seeing tight IT budgets, with customers extending the life of their assets and looking to the cloud as a way of avoiding long-term commitments and investments in new technologies.
The cloud actually benefits NetApp
Even though cloud computing has been such a hot topic lately, it is unlikely that most enterprises will fully adopt Amazon's vision of a public cloud. Instead, Gartner estimates that, by 2017, half of enterprises will deploy a combination of private infrastructure and a public cloud, known as a hybrid cloud.
NetApp has always been a company that's ready to partner, and even though the cloud is directly taking away its business, it is partnering with Amazon on the premise that this is what's best for customers. Since 2012, NetApp has been offering private storage that can be integrated with Amazon's AWS cloud. In this way, NetApp is using the hybrid cloud to maintain a certain level of demand for its hardware.
But the much bigger opportunity with the hybrid cloud might be in software. NetApp CEO Tom Georgens has stated that the gap between private and public cloud storage is large, and whoever can help customers bridge that gap will benefit nicely. NetApp already has software that manages storage across both its own and its competitors hardware, and Georgens said that this uniquely positions NetApp to help customers with the hybrid cloud.
Growth through M&A
In spite of repurchasing shares and instituting a dividend program in the last year, NetApp is still sitting on a big pile of cash -- about $4 billion net of debt -- that could be used for acquiring a promising new technology. Management has stated that they would be "very open to do M&A" that might help drive the growth of the company.
Within the storage industry, there are several hot new companies, such as Nutanix and Nimble Storage, that might make sense as acquisitions. Alternately, NetApp might look for a technology further away from its core business, particularly if it is serious about making the pivot to a hybrid cloud software provider.
NetApp's core business is being challenged by shrinking IT budgets and the rising popularity of the cloud. The company is trying to adapt by providing hybrid cloud storage in partnership with its competitor Amazon. But NetApp's real future might lie in providing hybrid cloud software, or in using its large pile of cash to acquire a new technology that will drive growth.
Srdjan Bejakovic has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Apple. The Motley Fool owns shares of Amazon.com and Apple. 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.