NetApp, Inc.'s Weakness Could Be a Buying Opportunity

NetApp has struggled this year, but it could get better on the back of innovation and solid adoption of its products.

Mukesh Baghel
Mukesh Baghel
Jul 15, 2014 at 1:00PM
Technology and Telecom

Trading at a forward earnings multiple of 11, with an expected earnings growth rate in the double-digits for the next five years, NetApp (NASDAQ:NTAP) looks like a value play.  The company operates in the fast-growing data storage industry, and stands to benefit from the growing deployment of data centers and hybrid cloud. However, the company's recent results haven't been impressive, as it is facing threats from bigger rivals such as VMware (NYSE:VMW), while International Business Machines (NYSE:IBM) is moving to its own infrastructure.

A weak performance
In the fourth quarter, NetApp's revenue fell year over year, missing consensus estimates by a whisker. The company also gave a disappointing outlook, projecting earnings per share, or EPS, of $0.53-$0.58 on revenue of $1.42 billion-$1.52 billion. Analysts, however, were expecting EPS of $0.62 on revenue of $1.52 billion. This hasn't helped NetApp's share price, which is down almost 10% this year.

However, this drop could be a buying opportunity as NetApp is making some impressive moves in terms of product development as discussed below.

Gaining traction
NetApp is counting on the continued adoption of cloud technology. The company is using its Data ONTAP solution to gain more customers in the cloud by delivering a comprehensive data management portfolio. The clustered ONTAP is useful for meeting IT transformation requirements of both enterprise and service providers. According to management, it is the only enterprise scale offering on the storage area network platform, and is easier to manage than other solutions. 

NetApp claims that ONTAP can consistently support multiple workloads with multi-tenant management and performance scaling across disk, flash and hybrid storage. Data ONTAP is gaining significant traction in the market due to the facilities that it provides. In fiscal 2014, the attach rate of clustered ONTAP jumped across all of NetApp's product lines, with 50% attach rates in high-end platforms in the fourth quarter. Particularly, the attach rate of its new FAS8000 product line increased more than 60%.

Its FlexPod unit shipments increased 71% year over year in the fourth quarter. NetApp sold over 18 petabytes of flash in the last quarter, crediting this success to its broad product portfolio and cutting-edge technologies. The company is trying to deliver value to businesses at a reduced risk. The company is working with best-of-breed hardware and software providers to deliver solutions that are a cut above its peers.

NetApp expects the adoption for its products to accelerate with the introduction of its newly refreshed high-performance controller platforms. NetApp introduced the FAS8000 product line during the fourth quarter, which is its first-generation of clustered optimized systems. This product has already gained substantial traction as seen above, recording the fastest initial quarter ramp of any system in its history.

Looking ahead, NetApp is investing in research and development to tap the emergence of new storage architectures. The company is working on the integration of cloud services and open-source solutions into its software-defined data management framework. The company needs to be nimble and agile on the product development front in order to land more customers, and more importantly, avoid losing existing customers.

IBM goes it alone
Recently, IBM decided to stop buying and reselling storage technology from NetApp as it moves customers to its own products. IBM is struggling as its hardware sales are declining, so it is encouraging clients to buy IBM-made offerings. According to Bloomberg, the company has withdrawn from selling NetApp's new N series systems, besides stopping product development support to NetApp.

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This seems like a significant setback for NetApp, as IBM is its largest OEM customer. However, NetApp gets only 2% of its revenue from IBM, according to Bloomberg. Even though IBM is now pushing its in-house products, apart from shifting its focus to newer technologies and product upgrades, it shouldn't be a setback for NetApp from a long-term perspective.

The VMware threat
One of NetApp's biggest rivals is VMware, which is pushing its virtualized servers aggressively. VMware is the leader in virtualization, commanding 64% of the market in 2013. The company is improving its position in the industry with the launch of its Virtual SAN product, while the vCloud Hybrid Service is enabling businesses to extend their data centers to the cloud.

VMware is strengthening its platform by adding security and backup services to deliver better solutions to customers. The vCloud Hybrid Service Disaster Recovery is a cloud-based service that gives customers an affordable solution to secure their data centers. In addition, VMware has partnered with several companies such as F5 Networks and Palo Alto Networks to bolster security across the physical and virtual environments of customers. 

The bottom line
NetApp does have its share of challenges. However, its product development moves look impressive. NetApp also looks like a value play, as mentioned above, and its fundamentals are sound. The company has debt of less than $1 billion, and cash of $5 billion, indicating a strong balance sheet. Its new products are gaining good traction, which means that NetApp can get better in the long run.