Storage giant NetApp (NASDAQ:NTAP) reported an 8% year-over-year decline in its storage product revenues to just over $1 billion on its recent earnings call. A large chunk of the company's storage product sales were its branded products (and associated services) with the remaining 6.6% made via the original equipment manufacturer (OEM) channel.
Earlier this week, IBM (NYSE:IBM) announced its decision to stop sourcing and reselling NetApp's N series products from May 27 onwards. A continued slump in its hardware sales coupled with a declining market share in the storage hardware market led IBM management to make this decision. IBM intends to focus on product upgrades and new technology products developed in-house. 
NetApp is likely to continue to witness growth from its non-product based revenue streams such as software entitlements and maintenance (NYSE:SEM) and hardware maintenance contracts. In its fiscal first quarter, which ended earlier this month, overall revenues generated by NetApp's SEM and hardware maintenance divisions combined grew by almost 6% over the year ago period to $605 million. 
Continual Decline In NetApp's OEM Channel
NetApp's mix of storage products sold via the OEM channel, which include products sold by companies such as IBM and Fujitsu, declined from about 21% in fiscal 2012 to 19% in fiscal 2013. The mix plummeted to under 15% of product revenues in FY 2014, with a surprisingly low 10% contribution in the last quarter of the fiscal year. The decline in the OEM mix in recent quarters was largely attributable to weakness in IBM's product channel, due to which IBM and NetApp have discontinued their nine-year old partnership. 
The revenues generated by NetApp's OEM channel declined by over 25% year-over-year to $585 million in the recently ended fiscal year, with branded product and services sales growing by a mild 2% over FY 2013. Consequently, overall product sales were down by almost 4% compared to fiscal 2013. 
IBM contributed approximately one-fifth of NetApp's OEM revenues, amounting to approximately $120 million in fiscal 2014. With the discontinuation of the partnership, NetApp's OEM channel is likely to continue to suffer in the coming quarters. With OEM sales already on the decline, the loss of a major partner could result in OEM sales declining even further. NetApp's OEM sales for fiscal 2015 could be as low as $350 million. The company has given a conservative revenue guidance of $6.1 billion for the year, which is almost 4% lower than revenues in the previous year. The company expects its branded revenues to grow at mid-single-digit percentages over the next few quarters, which could help the company to reach the upper end of its guidance range. 
Over the period of last two years, NetApp has reduced its debt levels from $2.3 billion to just under $1 billion. The debt reduction indicates management's confidence in the ability of the company to sustain healthy free cash flow.  NetApp had more than $5 billion in cash on its most recent balance sheet - a significant amount, given that its market cap is about $12 billion.
We have a $41 price estimate for NetApp, which implies a 15% premium to the current market price.
Disclosure: No positions.