How NetApp’s Strategic Product Sales Helped Drive Revenues This Year

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105
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96.70
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NetApp

It has been a tough few years for storage systems vendors as they battle through price declines and a low demand environment. Meanwhile, low-cost original design (ODM) manufacturers have further impacted established players by catering to the addressable market with white label storage boxes, which has led customers to transition away from leading IT hardware vendors. This has resulted in a loss of share for large players in the storage market, as evidenced by IDC-reported data. The combined share of vendors outside the five largest vendors increased from 25.7% in 2013 to 31.5% in 2015. Although this figure fell to 28.5% in 2016, it is important to note that for 2016 Dell’s revenues were added to combined Dell-EMC numbers, while they were calculated outside the top 5 before 2016, prior to the merger. In this environment, large storage vendors such as NetApp (NASDAQ:NTAP), Dell-EMC (NYSE:DVMT), IBM (NYSE:IBM) and HPE (NYSE:HPE) have reported year-over-year declines in storage revenues.

To counter this trend, NetApp’s management has focused on what it calls its Strategic Products, which primarily include Clustered ONTAP, E-Series storage products and SolidFire all-flash storage arrays. Comparatively, the company’s Mature product line largely refers to its older 7-Mode ONTAP storage arrays. The customer response to the company’s strategic products has been impressive this year, with NetApp reporting more than 20% revenue growth in strategic product sales in each of the last three quarters. In the same period, mature product sales have declined on a year-over-year basis. This has helped the company gain share in a slowing market, and has been a key contributor to its stock price rallying this year.

We have a $39 price estimate for NetApp, which slightly lower than the current market price. NetApp’s stock price has fluctuated between $35 and $45 this year.

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See our complete analysis for NetApp

NetApp’s Performance In The Market

Over the last few years, customer preferences have been shifting to low-cost original design manufacturer (ODM) storage boxes, which has cut into the addressable market for large vendors. As a result, the total market size for external storage systems shrank from nearly $25 billion in 2014 to under $23 billion in 2016, as shown below. In the same period, NetApp’s revenues declined from $3.1 billion to $2.5 billion, at a CAGR of over 11%. This was an uncomfortable time for the company, as it went through a series of poor results due to pricing pressure and low hardware demand, subsequently leading to a boardroom reshuffle in mid-2015. In this period, NetApp’s share in the market fell from 12.7% to under less than 11%, as shown below.

However, this trend has reversed in 2017, with the company reporting strong growth for its Product division. In the first half of the year, NetApp’s share in the external storage systems market was comfortably over 13%, with strategic product sales driving much of the revenue growth. NetApp reported a 24% and 20% year-over-year increase in strategic product revenues for Q4’17 and Q1’18, respectively. As a result, combined product sales were up 13% and 10%, respectively, in the two most recent quarters. It is interesting to note that NetApp has been the only large vendor to report a meaningful gain in market share this year.

Outlook For Coming Years

Over the last couple of years, it has been particularly challenging for NetApp as the only large storage-only vendor in a market with large competitors with deeper pockets and operations across various IT domains (such as Dell-EMC, HPE, IBM and Hitachi) and small competitors including flash-storage startups. However, NetApp has managed to gain traction in the market this year, fending off competition on both sides. We forecast NetApp’s storage hardware revenue to continue improve over the next couple of years, with all-flash array sales and Clustered ONTAP storage solutions driving growth.

We forecast NetApp’s share in the external storage systems market to increase to over 13% over the next few years, with storage hardware revenues expected to grow at nearly 4%. In the same period, the external storage market size is forecast to continue to fall at around 3%. It should be noted that the total storage systems market in terms of capacity and revenues is still an increasing market, with external storage as a percentage of total storage following a declining trend.

You can modify the interactive charts in this note to gauge how a change in individual drivers can have on our price estimate for NetApp.

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