NetApp is gaining share and has a strong market position. The company’s revenue growth is mostly organic and its balance sheet is strong. When you assess its OEM business and compare its progress to system/storage companies generally and EMC specifically, NetApp is poised for continued growth. This was the premise put forth by NetApp’s CEO Tom Georgens at the NetApp Analyst Summit 2012 in Sunnyvale, CA. His fundamental argument is NetApp is a product / technology company and when you squint through the numbers and isolate product revenue, NetApp is winning.
What follows are notes from Georgens’ comments at the NetApp analyst event with my editorial in bold.
1) Update/perspectives; 2) strategy itself
Update – Revenue ’07 – ’12: $2.8B, $3.3B, $3.5B, $3.9B, $5.1B, $6.2B – another year of 20%+ growth. ’11 all organic. ’12 acquisition related. NetApp has grown almost 60% in 2 yrs. 3/4ths of which is purely organic. 12K employees. $6.23B Revenue, 61% gross margin, 22% yoy rev growth , $1B in free cash flow, $5.4 in cash and investments.
Good year but below internal expectations. Growing pains with the growth of the company. Felt could have done better. Going into coming qtr – conservative guidance. NetApp Q1 – always the slowest. Europe concerns. Maybe things are better than expected. But one known is the #’s reported which for full year and qtr are very good.
Note: On its last earnings call, NetApp chose not to give guidance for FY ’13 full year results. Rather it guided analysts that growth in FY Q1 (always seasonally its worse) would be down 15% sequentially in revenue terms. This freaked analysts out a bit because they normally expect around a 10% decline in NetApp’s Q1 and the stock took a hit. NetApp cited concerns about Europe broadly (not just Greece and Spain) and US softness. As well, the company is heavily penetrated into the federal sector and political uncertainty has the company concerned. Georgens is generally not a fan of giving full year guidance, especially with so much economic uncertainty. NetApp has its annual financial analysts meeting next week in NYC and will make a case similar to the one that follows. While some believe the stock is oversold, especially as it dips below 30, others believe NetApp is feeling pressure from its biggest competitor, EMC. In my view Georgens is smart to keep expectations down as the big prize could come in the form of a new competitive position in scale out storage systems. If NetApp executes it will surprise on the upside in my view.
Market Share Discussion
IDC/Gartner have storage growing 7% in revenue terms. Independents growing…server guys losing share – despite meaningful acquisitions. Hitachi did better than expected given the loss of Oracle and HP relationships. EMC is a gainer through acquisition mostly. NetApp gained 1 pt last yr and 1 point yr before (net of Engenio). NetApp now accounts for 16.4% of the market. NetApp’s #’s are the high water mark because of it’s FY cycle—i.e. 16.4% is a bit overstated. Last 2 yrs – biggest market share gains in the history of NetApp. The data below are from a slide Georgens showed based on IDC data.
*EMC – 32.2%
*NetApp – 16.4%
*IBM – 11%
*HP – 9%
*HDS – 8.5%
*Dell – 7.9%
These #’s don’t include OEM business. Only reflects a subset of netapp’s revenue. (Note: IDC — for consistency reasons — counts storage revenue at the spending level so NetApp’s share of its OEM sales to IBM get counted as IBM revenue).
New way to look at it is storage revenue – storage biz as reported. (Note: This is not really new but I agree it’s a very useful measure because it’s what companies report; and unless they’re committing fraud like Miniscribe did by shipping bricks it’s a legit measure).
Storage portfolio of server vendors had some tough qtrs.. Dell – 5 neg growth qtrs. in a row. EMC’s product revenue declining growth. 4 consecutive declining qtrs.. Evidence of CLARiiON “clawback” and termination of relationship (dell? ) – overall storage business was flat (???).
NetApp most consistent growth performance across the entire year – even if you back out Engenio. The following trendlines are from a slide Georgens showed based on what companies reported in their earnings releases.
Growth % YoY for March / April Timeframe
NTAP Total – 23%ish
NTAP Product Only – 23%ish+ – growth rate steady – but slowing in the past year
EMC Total – 5%ish slowing in the past year
EMC Storage – 3%ish trending down in the past year
HP Storage – 1-2% growth – way up in the past quarter
IBM Storage – minus 3% trending down since the sept qtr
Dell – negative growth but at a steadily much slower rate
My PoV: Remember these are growth comparisons year-on-year. NetApp’s base is smaller than EMC’s but nonetheless it’s growth over the past couple of years has been impressive. I would expect to see NetApp continue to grow faster than the overall market. Dell is replacing EMC storage with its own IP so it can sell at lower prices and still make higher margin. HP is showing some strong growth with 3PAR which is now the company’s largest storage product in revenue terms. It’s challenge is to offset the decline of its legacy business with newer products. The big question is will the independents (EMC and NetApp) continue to outperform the integrated stack players (everybody else on this chart)? The challenge for EMC and NetApp is to create the integrate stack through partnership (e.g. with Cisco and VMware). So far this strategy appears to be working and imo is sustainable.
Storage 5000: Win a new account – expand the account. Dominate the footprint. Turn gray to blue and get a dominant position. Then get new accounts to bring into the funnel. New accounts, expand, protect/dominate…that’s the economic model of netapp. S5000 – fy12 – net new 169 accounts.
Migration of light blue to dark blue (i.e. from grow to protect). Government (netapp #1), EMEA, financial services – large accounts grew. Ability to cycle accounts and gain share in them …
Since FY’07-’12, NetApp has gained 135, 151, 175, 109, 93 and 169 new accounts.
Growth accounts have grown from 995 – 1387 over that period
Protect accounts have grown from 420 – 725 in that timeframe.
My PoV: About five years ago, NetApp unveiled a plan to go after the 5,000 largest storage accounts on the planet. I’m very impressed that NetApp shared this strategy publicly and has reported metrics over that period of time. That obviously means it’s working. NetApp has been very deliberate to become more well know in the enterprise and the S5000 strategy is paying dividends, especially as it relates to partners who previously would not have prioritized NetApp.
All the Wood Behind One OS Arrow
OS share – Ontap #1 in market share. For OSes. ONTAP market share is widening. (Source: NetApp). EMC’s acquisition of Data Domain has been a big contributor to EMC – but that means the rest of EMC’s business is losing ground. NetApp by having 1 main OS with dominant share will allow it to invest more in the OS than anyone else can in any single OS. NetApp can out innovate the competition by putting all the wood behind one arrow. ONTAP 7-8 conversion was difficult but it’s done now. Major source of R&D leverage.
Market share – individual OS is interesting but not expansive. Total storage too narrow. NetApp is the #1 oem supplier in the world – how to measure? NetApp’s aspirations must include OEM business. Building on the idea of market prescence. What if we measure end user value (e.g. HDS credit for HP, NetApp credit for IBM) – i.e. spending for the technology. Measure of headroom in the market and strategy.
Data shown by NetApp fro 2002 – 2012 had ONTAP’s revenue share growing steadily from 9% to over 15%. Enginuity steadily dropping from 20% down to 10% in 2009 and trending slightly up thereafter. Flare growing from 6% in ’02 peaking in ’05 at 15% then trending down to 8% and flattening out with Dart flat to up over the period bouncing between 9-10%. Finally Data Domain starting at near zero percent growing to 5% of the total.
My PoV: Even though NetApp is the source of this data I love the slide. It reminds me of the old Scott McNealy adage of putting all the wood behind one arrow. Before you ask “how did that work out for Sun?” remember that a single unified architecture was put forth as a vision from NetApp around ten years ago. EVERYBODY in the industry has copied or tried to copy its moves. And yes, the company bought Engenio and that breaks its one OS model. But the fact remains that NetApp has done incredibly well in block based storage environments without a native block product. Its unified strategy has been an unquestionable differentiator and with its new clustering approach with ONTAP 8.1.1 it is the fundamental competitive strategy NetApp is using to disrupt traditional tier 1 block-based competition. The rap on WAFL has always been it doesn’t scale. The opportunity for NetApp is that if it can get ONTAP 8.1.1 proven to work technically at scale, NetApp could break the decades long mold of separating block and file at the high end. This is NetApp’s next battleground and the company is making a big bet that it will work.
Creative Math – AKA “Georgen-Omics“
NetApp’s market share if you blend in the value of NetApp’s and EMC’s OEM deals was shown in a slide by Georgens with the following data:
EMC w/OEM at 32.4%
EMC w/o OEM at 32.2%
NTAP w/OEM at 24%
NetApp w/o OEM at 16.4%
What’s the conclusion? – virtually all of EMC’s market share gain is a reclassification of the Dell revenue and doesn’t have anything to do w/data Domain. This is the closest NetApp has ever been to EMC – based on the definitions NetApp has.
My PoV: Okay…this one was kind of a stretch. What Georgens did is to add in the value of his and EMC’s OEM revenue to the IDC market share data. I give Georgens credit for the point he’s trying to make– i.e. that NetApp’s product business is stronger than the IDC share data shows.
However I think Data Domain is growing rapidly and I don’t buy the conclusion that it’s not contributing to EMC’s growth. Further, EMC has done an unbelievable job of growing its business despite the loss of Dell as a major partner. I think Georgens’ analysis conveniently includes OEM, a business that EMC really doesn’t have now that Dell is gone (notwithstanding Unisys and Siemens) and excludes storage services. Like it or not…EMC sells tons of services. Services are a secret weapon for EMC in storage. You could roll back the clock 10 years and EMC could make similar claims that NetApp is making today—i.e. focused product portfolio, strong product growth, small relative services contribution, decent OEM business (remember HP). But EMC is a more than 3X the size of NetApp and had to make the move into services and software. To ignore storage services as a viable measure of success is clever positioning and serves NetApp well – but the reality is investors, analysts and observers do and should include storage-related services in the assessment of success.
The interesting question is whether NetApp’s success model will have to change as it grows. Can its core architecture lead the way to scale out models? Will it have to acquire to grow and will it need to eventually vertically integrate into more software and services? Or is NetApp unique in this regard because of its product architecture and culture?
NetApp has had some very tough compares over the past several quarters and I suspect Georgens is smartly being cautious. Better to take the hit now and beat expectations than try to pump up the company in an uncertain environment and pay the price down the road. Either way, my bet is at a certain size, NetApp will have to get more acquisitive to continue its growth trajectory…much in the same way EMC had to do so.
1) Speed – Just about every major initiative and transformation – IT is the gating item to implementation. If IT were faster it could create competitive advantage for the firm. How do we enable speed?
2) Economics – economics determines all outcomes and trumps technology – once CEO said “storage is recession proof” during the dot.com. Ruettgers (sp?) = economics forces tradeoffs and opens the door for innovations. No coincidence that during the downturn, netapp grow customers faster
3) Scale – over 100 5PB+ clients.
Other things like reliabililty are table stakes – but if you can move the needle on 1,2 or 3 – you can change customer buying behavior.
Framework for growth. How to grow? Create comp. advantage around speed, economics and scale.
-Starts with product and innovation / leadership. NetApp at its core is a technology company.
Focus breadth or depth – only a finite amount of R&D but there’s only so much we can do. It all comes down to good products sell and bad products don’t. NetApp wants to be the best of breed for the markets that are the largest. NetApp must break the one-stop-shop option. NetApp’s story is that focus, not breadth is the advantage that NetApp brings.
So where we are going to focus? TAM expansion and new opportunities.
ONTAP 8 is the industry’s richest data management platform. NetApp is taking that technology and merging it with the architectural capabilities of clustering – and bring these two technologies together. The richest data management feature set with the architectural capabilities of clustering.
Gravitational pull – easy to visualize this technology as scale out NAS to support unstructured data growth. NetApp has the largest NAS deployments in the world – clustering only furthers this lead. Second is virtualization. Be the platform of choice for virtualization. If NetApp can enable VMware and MSFT to virtualize more apps…that plays to netapp’s strengths.
Premise: Clustering allows NetApp to bring its products to the mission critical side of the equation at scale.
Why has NetApp been able to grow so rapidly over the past couple of years? Answer is virtualization excellence within the data center.
Big untapped profit pool is scale out space. Fundamentally different approach with an unquestioned value prop. Biggest profit pool is mission critical, non-stop operations.
My POV: This is an ambitious challenge for NetApp. In a way it’s done this before – i.e. bringing simplicity to data center apps. But these apps were largely ripe for the picking – e.g. Microsoft Apps or certain Oracle use cases that lend themselves to NAS. Georgens is essentially saying he’s going after VMAX – the heart of EMC’s profit engine. The key to this however will be the degree to which NetApp and its partners can bring the service excellence that EMC and IBM have achieved in these accounts.
NetApp has a big play in leverage structured and unstructured information assets. This is what ONTAP 8 does.
The other part of the story is some of the infrastructure won’t be virtualized.
Why is there no 70% storage market share leader? It’s because the market is fragmented – unlike networking. So you need to have a diversified channel strategy. How does NetApp project a scale that can match the whales? The answer is partnerships.
Server guys’ value prop is not innovation—it’s integration. What if NetApp can partner up with the likes of VMware, Cisco and others…and demonstrate equal levels of integration…it can win because it can deliver better products.
Flexpod is an example and has far exceeded Georgen’s expectations.
Partnerships are NetApp’s strategy – it’s how the company competes with EMC and the large server guys.
Growth opportunities –
-High growth workloads
-Significant opportunity in S5000 and MSE
-No dominant player
-Expanding addressable market through technology innovation
-Partner for scale
Closing thoughts – Europe is dreary. OPEC complaining about growth. Economic tension challenges the status quo. CEO won’t sacrifice business to store more data. 2008 and 2009 we saw slower growth but new customer acquisition was outstanding and strong growth followed. At the time – storage efficiency was the value prop. Today – with ONTAP 8 the value prop is the fundamental way to build storage as infrastructure at scale – speed
ONTAP 8 has been a long time coming – it’s a big bet and there’s nothing else like it in the business. The technology is compelling, differentiated and finally real.
My take on Georgen’s discussion is as follows. First he’s unambiguous. NetApp’s strategy is to make big bets on a focused set of hot initiatives and remain true to being an independent storage firm—truly the only large independent storage company left (it’s getting lonely). The company is entrenched in virtualization and is now moving on to scale out. It’s taken a long time to get here but no one owns that space at the moment. NetApp has crushed it over the past two years, making year on year comparisons extremely difficult. As such, Georgens has had to go on a TAM expansion mission and that’s what the Engenio acquisition was all about—increasing the addressable market and giving NetApp a dominant OEM play.
The question is, after twenty years of phenomenal innovation, what’s next for NetApp? Can the company remain independent long term and continue to thrive? Right now, with a market cap of $11B that looks likely. However, EMC has more than 3X NetApp’s revenue but when you strip out VMware, EMC has a market value that is only 2X that of NetApp. Is EMC undervalued? Is NetApp overvalued? Can WAFL, the fundamental building block of NetApp’s $6B franchise take the company through its next twenty years? Or like EMC before it, will the company have to diversify through acquisition. Can NetApp replicate the integration prowess of the large system vendors through partnerships?
In the near-to-mid term, if ONTAP 8.1.1 clustering works technically, I think NetApp could do some serious damage by challenging the status quo notion that high end block and file need to be separate. And challenging the notion that WAFL doesn’t scale. If clustering flops, NetApp’s big bet will be a disaster. The real challenge (assuming it works) will be the degree of complexity customers must endure to both migrate and manage clustered, unified storage. Making it simpler to manually move data at scale (in my view) is not an option. Rather NetApp must automate data movement and make data management automatic. Its lack of an automated tiering and (so far) weaker flash story is problematic in this regard in my humble view.
I believe NetApp will over time have to diversify through acquisitions, leading to the question– Can NetApp improve its acquisition execution and get a better ROI on acquired IP? Engenio, a company Georgens knows well may be the turning point. The bottom line is NetApp is a serious player that keeps getting stronger. Despite some bumps in the road with Wall Street analysts, I predict the company will continue to outpace the competition in terms of product share gains. Yes there are some gaps in the portfolio such as flash, but ONTAP 8.1.1, if it lives up to expectations, will give NetApp considerable competitive advantage.
Services is another wildcard. NetApp is clear it’s not trying to be a services company. EMC touts this as well but the reality is EMC has a very profitable and growing services business that throws off tons of cash. NetApp doesn’t. In the near term, NetApp can use this fact for its tactical marketing advantage. Over time however, services will increasingly become a differentiator for EMC and at some point I predict NetApp will have to take the services plunge.