NetApp's Software And Services Underpin Growth And $37 Fair Value

| About: NetApp, Inc. (NTAP)

NetApp (NASDAQ:NTAP) posted a its Q2 earnings on November 14 with revenues coming in at $1.541 billion, up slightly y-o-y. The revenue was in line with the guidance provided in Q1. Despite tough macroeconomic conditions, EPS came in above guidance provided as GAAP net income was $110 million, or $0.30 per share, compared to GAAP net income of $166 million, or $0.44 per share last year. NetApp is involved in designing solutions for storing, managing and protecting business data through enterprise storage and data management software as well as hardware products and services. NetApp also estimates Q3 revenues to be in the range of $1.575-$1.675 billion, EPS is expected to be $0.29 to $0.34 a share [NetApp Q2 Results,, Nov 14, 2012]. We explain some key business developments and changes to our valuation below.

Services And Software Growth Outpacing Hardware Decline

Storage hardware is the most valuable division of NetApp, constituting nearly 40% of its value while Software and Consulting Services constitute nearly 30% of its current value with cash making up the rest. On a year-over-year basis, product revenue fell slightly from $1.016 billion in 2011 to $996 million in 2012. This decline was however negated by growth in software revenue, which climbed 10% from $198 million to $219 million and services revenue, which grew 12% from $293 million to $326 million. This trend is likely to help margins as we estimate that product gross margins to be in the low 50% range while services margins are slightly higher nearing 60% and software margins are much higher nearing the 90% mark. The downturn in hardware revenue is short term and is likely to pick up as IT spending improves.

Changes To Our Valuation

We discuss business drivers and segments driving NetApp’s business and why it is currently undervalued in our post here. We revised our R&D cost drivers upwards to be in line with the current quarter’s report and adjusted margins based on the earnings call and this had led to a slightly lower valuation for its stock [NetApp Management Discussion,, November 14, 2012].

Cloud Storage, Big Data And StorageGRID Key for 2013

Product revenue took a hit on Q2 due to seasonality and macroeconomic factors, but hardware maintenance contracts showed robust growth and is likely to positively impact margins.

StorageGRID software now comes with the Cloud Data Management Interface (CDMI) standard. This is developed by the Storage Networking Industry Association (SNIA) and involves interaction of applications with cloud storage. It covers activities such as the creation, retrieval and deletion of data elements from the cloud and is an open standard for self-provisioning and accessing cloud storage. This is a shift away from proprietary API’s and interfaces that ties clients to its storage vendors as CDMI is a more open approach aimed at reducing vendor dependability. In essence, a company can change cloud storage vendors easily and is not dependent on a single vendor. Currently, NetApp is one of the few large storage vendors that supports the standard, and we expect this to drive its revenues as it will be able to better manage clients’ storage needs [NetApp StorageGRID,, August 13, 2012].

We currently have a $37.53 Trefis price estimate for NetApp, which is about 40% higher than its market price.

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