NetApp: Sustained Transformation

About: NetApp, Inc. (NTAP)
by: Stone Fox Capital

NetApp continues to rebound as investors absorb the initial disappointment with guidance.

The dilutive impact of the SolidFire deal sets the company up for growth in FY18.

The stock trades at an incredible value after the Q4 plunge.

Similar to a lot of large technology companies, NetApp (NASDAQ:NTAP) remains in a constant transformation loop. The company builds new storage products that struggle to maintain overall revenue levels as legacy products lose steam.

The transformation though continues to leave the stock trading at multi-year lows while the company produces strong free cash flows. Despite weak guidance, the stock is actually bouncing higher on hopes for stability going forward and the possibility of a boost from the purchase of fast growing SolidFire.

The stock traded volatile due to FQ4 guidance and another workforce reduction. The continued slashing of employees has a way of demoralizing the remaining employees. NetApp has repeatedly reduced employee counts over the last several years. Still, the slashing of 12% of the workforce and eliminating $400 million in costs provides support to the sustained transformation.

The market was disappointed with FQ4 guidance though it doesn't appear that investors were fully including the dilutive impact of the SolidFire deal. The deal is expected to ramp toward accretive benefits in FY18, but the company again forecasts taking a $0.28 to $0.30 hit in FY17. Though the deal closed on February 2, one has to conclude that a ramp of the SolidFire revenues means a rather big earnings hit in these initial months and quarters.

The initial disappointment in the stock centered around the guidance of $0.55 to $0.60 for FQ4 compared to the expectations at $0.72. It seems irrational that investors expected NetApp to guide toward an increase in the EPS number of $0.65 from last year. Assuming the normal quarterly beat of NetApp and adding in up to a $0.07 hit from SolidFire, one easily sees that the company would actually approach the analyst target without the dilutive impact of SolidFire.

Outside of that, the transformation picture remains mixed. NetApp sees strategic revenues growing 26% YoY and now accounting for roughly 55% of revenues. At the same time SolidFire will add somewhere around $30 million quarterly to strategic revenues going forward.

With the stability in the business going forward in part due to the SolidFire purchase, NetApp can return to the large capital returns. The tech stock offers a decent 3% dividend yield and is very aggressive in stock buybacks.

After holding back during the last quarter in part due to spending $870 million in cash on SolidFire, the company can now return to buying the stock at multi-year lows. Over the last year, NetApp has repurchased a large part of the stock. Combining the stock buyback yield with the dividend yield, the company has a large net payout yield of 15.3%.

NTAP Net Common Payout Yield (<a href=

NTAP Net Common Payout Yield (TTM) data by YCharts

Even after borrowing $870 million for SolidFire, the company has net cash of around $2.6 billion. In addition, NetApp produced $314 million in free cash flow for FQ3 alone. The ability to generate cash along with a rock solid balance sheet makes the stock very attractive.

The key takeaway is that the transformation is lumpy, but sustainable. NetApp may never see improving revenue trends, but the balance sheet and cash flows are too valuable for the stock trading at these levels. Based on an enterprise value of only $4.5 billion due to the nearly $9 per share in net cash, the stock trades at an enterprise value of roughly 6.5x analyst EPS estimates of $2.36 for FY17. The recommendation is to buy the stock for conservative portfolios looking for value.

Disclosure: I am/we are long NTAP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.