Let's Reassess NetApp

 | Aug 16, 2011 | 9:56 AM EDT
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You'd think that, with all the chatter about cloud computing, NetApp (NTAP) would be flying high, but it isn't. The stock is 27% off its 52-week high.

With the company scheduled to report Aug. 27, I decided to take a peek. Maybe Skynet and the quantitative-analysis screens have unfairly punished the company? Perhaps this is a good time to get into a well-managed, high-quality tech company?


Despite recession and fears of another global economic slowdown, the storage business continues to grow like crazy. Earlier this year, research firm IDC said digital packrats purchased a totally of 4.956 petabytes of storage capacity in the fiscal first quarter, up 46.3% year over year. In addition, IDC said total disk-storage systems market hit $7.5 billion in the quarter, up 12% over the prior year. External disk storage systems grew 13.2% to $5.6 billion. (IDC breaks the storage business into two main businesses: disk storage systems and external systems.)

Revenue should grow approximately 25% in fiscal 2012 and another 12% to 15% in 2013. In May, NetApp completed the acquisition of Engenio, a maker of external storage systems. Because Engenio has lower operating margins than NetApp, the deal has weighed on the stock. Investors are afraid the acquisition will stall the eight-quarter streak of operating-margin improvement. In fact, in the first quarter of last year, operating margins were just 2.35%. On Wednesday, investors expect the company to report operating margins of between 15.5% and 15.8%.

In the April quarter, NetApp reported sales of $1.171 billion, up 22%. For the first quarter ending July 31, the Street expects revenue of $1.51 billion, up 32.5% and earnings of $0.45 per share, up 15.4% from a year ago. (Note: Some estimates may or may not include acquisition related expenses and one-time items of $0.12 per share in fiscal 2012, so don't get too excited when the company reports better-than-expected results.) For the year, analysts are forecasting total revenue of $6.74 billion, up 31%, and EPS of $2.15.


The Engenio deal has investors questioning the company's strategy since the former uses a distinctly different storage array technology. The company has lower operating margins, and some are concerned that NetApp will end up with a "fractured" product line or overlapping products that do not mesh together -- something for which EMC (EMC) has been criticized.

But management promises the Engenio integration won't be a big deal since the technology helps address gapping holes in NetApp's product lineup, of which there are a few. (For example, NetApp really doesn't address full-motion video capture and high-performance computing.)

I personally believe NetApp will find ways to make the Engenio deal work, especially since the former CEO of Engenio is now the CEO of NetApp.

If the tech sector is able to shake off worries about a global slowdown, the storage stocks will bounce back. If investors take advantage of the recent weakness, perhaps they may be able to store up some gains.

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