Data Storage Sector Succumbs to Takeover Fever

by: Investment U
By Tony D'Altorio

Not that long ago, Dell (Nasdaq: DELL) made a $1.5 billion bid for 3Par (NYSE: PAR), which creates high-end storage systems and data management products. Its intent: to break into the IT services business. Rivals such as IBM and EMC saw that as a direct challenge. And Hewlett-Packard (NYSE: HPQ) disliked the move so much, it waged $1.6 billion of its own.

That should come as no surprise, considering its bold acquisitions over the past few years. Its recent catches include network device maker 3Com, mobile device company Palm, and tech services provider Electronic Data Systems. But not to be left behind, Dell followed HP into several of those markets. Most notably, it bought Perot Systems last year after HP took on the far bigger Electronic Data Systems.

And it looks like this sector’s merger mania isn’t over yet.

Takeover Fever Rages On

Corporate takeover fever has been going on for years, especially in data storage. This came into sharp focus last summer, when EMC outbid rival NetApp (Nasdaq: NTAP) to buy Data Domain.

Meanwhile, some of the largest technology firms – HP, Cisco Systems (Nasdaq: CSCO), Oracle (Nasdaq: ORCL) and IBM – have all focused on the storage boom from the rising popularity of cloud computing services and virtualization.

Big corporations keep growing larger, more sophisticated computing frameworks. That has led to a data storage switch from hard drives to remote server locations, and servers performing more specialized processing. In addition, companies want easily accessible data from multiple locations that are still responsive to stronger analytical demands.

Today, we see all types of data being collected and stored. Telecommunications companies now collate information on every call, retailers track every sale and stock exchanges keep tabs on every trade. So it should come as no surprise that figures show total data collection doubling every 18 months. And the need for storage grows right along with it.

Big technology sellers like HP and Dell want to help their larger customers take advantage of this trend. They want to add sales of storage solutions and analytical tools to their existing products. In other words, they want to offer one-stop shopping for all their customers’ technology needs.

Morgan Keegan analyst Brian Freed says: “What we’re seeing is a shift towards convergence. You have these one-stop shops forming that span everything from servers to networking and storage. You’re going to see this natural consolidation of hundreds and thousands of players into a smaller number of dominating players.”

The Data Storage Sector: Takeover Targets Abound

The data storage sector’s rapid growth has made even high takeover offers pay off so far.

Industry insiders criticized Dell for paying 10 times revenue for EqualLogic in 2007. But annual sales there have since soared to $800 million from $140 million. Some have since labeled it “Dell’s deal of the century.” So the company likely didn’t feel bad about offering an 87% premium for 3Par’s stock.

All the same, 3Par hasn’t made an operating profit in five years. On sales of $235 million in the year ending March 2011, analysts expect it to generate $21 million of earnings - before interest, tax, depreciation and amortization. That means HP is paying almost 80 times those profits! In order to justify paying such an exorbitant price, 3Par has to grow. A lot.

Its investors might want to ask management to look for better ways to spend $1.6 billion. Yet stock market participants seem to confidently accept the prices without question.

In fact, 3Par rivals Compellent Technologies (NYSE: CML) and Isilon Systems (Nasdaq: ISLN) have also been bid higher in anticipation of more takeovers.

Despite the sky-high valuations, optimistic investors may be right. After all, technology companies are sitting on more cash than most other industries. So they don’t have to rely nearly as much on debt markets to fund purchases.

With that in mind, the biggest prize in the storage sector is still sitting untouched: EMC. At this point, only a few companies can afford to court it, including IBM, Cisco and HP.

So keep your eyes on all four businesses as the data storage sector continues to light up around us.

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