How A Market Share Loss In Storage Systems Could Impact NetApp’s Stock Price

-7.88%
Downside
105
Market
96.70
Trefis
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NTAP
NetApp

Storage giant NetApp (NASDAQ:NTAP) has seen some weakness in product sales over the last few quarters, with its services division driving much of the company’s top line growth. The company recently reported a 7% year-over-year decline in its product revenues to $3.65 billion through fiscal year 2015 ended April. Software maintenance revenues were about 2% lower than the previous fiscal year at just about $900 million. On the other hand, hardware maintenance and services revenues were up by 7% y-o-y to $1.57 billion for the full year to partially offset the decline in product revenues. Correspondingly, NetApp’s overall revenues were about 3% lower than FY 2014 levels at $6.12 billion.

Moreover, the gross margin (GAAP) of the services division improved by almost 3 percentage points to 62.0% for the full year. Comparatively, gross margins of both product and software maintenance were down by 30 and 60 basis points to 54.7% and 96%, respectively. As a result, the company-wide gross margin was up by 65 basis points to 62.6%.

Despite weakness in its storage product division, which primarily includes storage system (hardware and corresponding software) sales, we have a slightly optimistic forecast for NetApp’s storage products division. In this article we explore the possibility of continued weakness in NetApp’s core storage business and its potential impact on our valuation for the company.

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We have a $39 price estimate for NetApp’s stock, which is over 15% higher than the current market price. NetApp’s stock price has fallen by over 18% since the beginning of the year.

See Full Analysis For NetApp Here

Loss In Storage Systems Market Share (-15% Impact on Stock Price)

Global spending on storage systems has witnessed a slowdown in recent years, with total factory revenues growing by 18% in 2010, 10.9% in 2011 and 4.8% in 2012. According to IDC data, total factory revenues generated by external storage systems declined by 0.4% in 2013 and 0.4% in 2014 to $24.5 billion. NetApp’s share in the storage hardware market steadily rose from 11.1% in 2010 to 13.1%  by the end of 2013. The company lost market share in calendar year 2014, which can be partially attributed to the termination of the IBM-NetApp deal in May last year, which led to low OEM revenues.

NetApp was one of the few large storage system vendors to have maintained its market share through the first half of 2014 at over 14% in the storage systems market. The company witnessed strong demand for its all-flash arrays and storage units with attached clustered nodes in that period. However, the company’s product sales suffered in the December quarter and managed a mere 10.7% share in global external storage system sales. As a result, its share for the full year stood at 12.8%, which was about 25 basis points lower than 2013 levels.

Most large storage providers including EMC (NYSE:EMC), NetApp, IBM (NYSE:IBM) and Hitachi Data Systems lost share in the market through 2014. These companies lost share to some of the smaller storage vendors such as Pure Storage, Violin Memory, Nimbus Data and Solidfire. [1]

NetApp introduced a significant number of new products including all-flash storage array FlashRay, the Data ONTAP 8.3 operating system, Cloud ONTAP software for usage in public clouds and the new range of products from the SteelStore acquisition. As a result, we currently expect the company to grow strongly in the coming quarters on the back of a revamped product lineup, strength in the storage software market and its presence in the fast-growing converged infrastructure and flash array market. Correspondingly, we forecast NetApp’s share to continue to rise, albeit more gradually than historic rates, to about 14% through the end of our forecast period.

In this alternate scenario we explore the possibility of NetApp losing share in the external storage systems market. As evidenced by data compiled by IDC’s quarterly storage systems tracker, smaller companies captured market through 2014 at the expense of larger storage providers. [2] [3] [4] [5] The main reason for that is the flexibility/customizable solutions offered by flash-array startups at prices that larger companies are unlikely to match. In the long run, smaller flash storage providers could get bought over by larger companies (recent acquisitions include Skyera, Fusion-io, LSI Sandforce, XtremIO, sTec and Velobit). However, if smaller companies continue to undercut larger firms without any major acquisitions, it could result in a nearly constant 12-13% share in the external storage systems market for NetApp.

If NetApp’s share in the hardware market stays at current levels, the resulting storage software revenues are also likely to suffer. In our scenario we assume NetApp’s market share to gradually decline to about 12.1% in 2021 from 12.8% at the end of 2014. Furthermore, we assume storage software revenues to decline to about $500 million from $655 million in 2014. Our third assumption centers around the product gross margin. We currently forecast NetApp’s adjusted storage gross margin to gradually rise from 56.3% in 2014 to over 59% by the end of the decade due to a favorable product mix including all-flash storage. Margins could take a hit if the company decides to reduce prices to sustain share in the highly competitive storage hardware market. We further assume that NetApp’s gross margin stays at current levels through the end of our forecast period. Combining these three assumptions, we get an approximately 15% downside to our current price estimate for NetApp. You can modify the interactive charts to gauge a change in storage systems market share, product gross margin or storage software revenues can have on our price estimate for the company.

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Notes:
  1. All-Flash Arrays Offer Strong Opportunity For NetApp Despite Competition, Forbes, June 2014 []
  2. Worldwide Quarterly Disk Storage Systems Tracker Q1 2014, IDC Press Release, June 2014 []
  3. Worldwide Quarterly Disk Storage Systems Tracker Q2 2014, IDC Press Release, September 2014 []
  4. Worldwide Quarterly Disk Storage Systems Tracker Q3 2014, IDC Press Release, December 2014 []
  5. Worldwide Quarterly Disk Storage Systems Tracker Q4 2014, IDC Press Release, March 2015 []