Monday, August 13, 2012

NetApp and Cisco Warn, Is Tech Really that Weak?

NetApp (NASDAQ: NTAP) reported a good set of results but spooked the IT market with its guidance and dragged many tech stocks down with it. Following so soon after Cisco Systems (NASDAQ: CSCO) did exactly the same thing, most tech investors are now entitled to ask whether this is a clear sign of a broad based slowdown? 

I think the answer is yes and no. It is yes in the sense that macro-economic events will dictate IT buyers’ sentiment. However, it is no with regards to the quantum compared to these two companies. In other words, whilst I think issues with Europe and global Government spending are serious, I also think there are signs that these two companies are facing competitive pressures.

Different Stories, Same Conclusion?

NetApp’s guidance was horrible and significantly below market estimates. Management stated it would do away with giving full year guidance on this conference call and, at the upcoming Analyst Day in June. NetApp guided next quarter’s midpoint to a 15% sequential decline (where the usual is a 10% decline) and, a 1% annual year on year decline. It chiefly blamed the broader macro-environment, but Europe and Global Public spending were also extensively cited as these end markets are relatively more important to NetApp. Financials were cited as being a potential sign of weakness and, one refrain heard in the conference call, was the reference to Cisco’s weak guidance reflected in NetApps conservative outlook.

Incidentally, One firm was right on the money with their prediction for these results and I would suggest listening to them in the future with regards NetApp. A few weeks earlier, Piper Jaffray had written this.
“We expect NetApp to report FQ4 revenue toward the high end of guidance, but provide a cautious outlook for FQ1 due to weakness in Europe and uncertainty in the public sector. We still believe NetApp can deliver market share gains over the next four quarters, driven by the recent launch of ONTAP 8.1, the ramping growth of both the 2240 and Engenio.”
NetApp’s explanation for the guidance is compelling and the citation of Cisco’s guidance appears to give it more creditability. However, I have my doubts. Principally because, they said different things!
Essentially, Cisco talked of the key changes to end demand coming from weakness in broad based enterprise spending. As for the public sector and Europe, Cisco has been blaming those two end markets for a while now, so they are not the reasons for the change. I looked at Cisco at the time of the results in an article linked here. In summary, I think there is a strong argument for the fact that Cisco is experiencing growing competition in its core switches and routers division, and a trend decline in telepresence.

In contrast, NetApp is highlighting the public sector and Europe as being the main cause. Whilst, I appreciate there is an overlap, the discrepancy is meaningful and it does not suggest broad based weakness. Rather, it suggests these two companies have seperate issues. Interestingly, both companies are seeing strengthening competition and, I think this aspect is key too. With Cisco it’s Huawei while for NetApp it's EMC (NYSE: EMC).

Cold Storage?

Storage always has been a competitive market and this causes variability in quarterly results for the leading players. Whilst Dell reported a poor quarter, the restructuring efforts at Hewlett-Packard (NYSE: HPQ) suggest that it can build on its 1% increase in storage revenue for Q2. EMC is the market leader and, contrary to NetApp, recently made positive noises about the marketplace and reported a 3% increase in storage product revenues.

The other major players are IBM (NYSE: IBM) and Hitachi. According to IDC Storage Tracker, EMC has the biggest market share of the External Disk Storage Systems Market with nearly 30%, IBM has around 15% and the other three fluctuate at around 8-12%.  Whilst the immediate attention will be on the competition from EMC, I think that IBM has been active in launching new storage systems products.

All of which leaves a rather confusing picture. NetApp reports an excellent set of results but the guidance is horrible. It cites Cisco, yet argues a different case. The other industry players seem to be doing ok, yet this is a decidedly weak outlook from NetApp. Confused? You should be!

NetApp Worth a Net Add? 

Investors who don’t like uncertainty (I’m one of them) won’t be interested in NetApp.  Yet, the stock has many attractions to a value investor. It holds $4.1bn or nearly 40% of its market cap in net cash or cash-like investments. Its current PE is less than 12 and its EV/Ebitda multiple is less than 6. Simply put, the stock is now priced as a ‘no growth cash cow’. Also, NetApp has converted around 20% of its revenues into free cash flow over the last few years.

I can’t help thinking that if a company like IBM were to come along and buy NetApp at its current price for $10.1bn it would get $4.1bn in cash, plus probably close to another $1bn in free cash flow generation within a year. It would also increase its market share in storage to something close to EMC.
I wouldn’t advocate buying a stock on this basis, but it does go to show how cheap NetApp is.  If this turns out to be a false alarm over guidance than the stock will start to look very cheap. And let’s recall that if this is a bit of short term negative sentiment caused by the European Sovereign debt crisis than, this is an issue which could be resolved by EU action. However, if this is a more pervasive issue of NetApp losing market share in the future, it will be a different story.

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