SSB on storage
Computer Storage
Adjusting Ratings, Estimates and PTs Downward.
March 8, 2001 SUMMARY
* While we continue to believe in the longer term appeal of
H. Clinton the storage industry and see storage as a relative
Vaughan outperformer, we also continue to feel that storage stocks
and their fundamentals will be under pressure in the near
term. Therefore, we are adjusting our ratings to reflect our
John C. Dean near term caution.
* Brocade 1H-->2H (target $44), EMC 1M-->2M (target $45),
Inrange 1H-->2H (target $24), and NetApp 2H-->3H (target
$29).
* Although we recognize that much of the downside risk is
reflected in current stock prices, we cannot ignore looming
fundamental erosion which has been caused by an economic
downturn.
* We note that these companies continue to execute very well
and that our rating adjustments is based on macroeconomic
weakness, nothing company specific.
SUMMARY VALUATION AND RECOMMENDATION DATA
Earnings Per Share
Company (Ticker) Price FYE Rating Target LTGR Current Yr Next Yr
BROCADE Communicatio- $38.50 Oct Curr 2H $44.00 50% $0.53E NA
ns (BRCD) Prev 1H $56.00 50% $0.57E NA
EMC Corp. (EMC) $43.00 Dec Curr 2M $45.00 30% $0.95E NA
Prev 1M $50.00 30% $0.96E NA
Inrange (INRG#) $16.38 Dec Curr 2H $24.00 30% $0.30E NA
Prev 1H $29.00 30% $0.30E NA
Network Appliance- $29.31 Apr Curr 3H $29.00 50% $0.41E $0.51E
(NTAP) Prev 2H $50.00 50% $0.41E $0.55E
OPINION
Ratings Changes
---------------
While we continue to be convinced of the strong long term growth opportunity
of the storage industry, we also continue to feel that storage stocks and
their fundamentals will be under pressure in the near term. Therefore, we
are adjusting our ratings to reflect our near term caution.
UpdatedPrior Target
Company Ticker Rating Rating Price
Brocade BRCD 2H 1H $44
EMC EMC 2M 1M $45
InrangeINRG 2H 1H $24
NetApp NTAP 3H 2H $29
Definitions of ratings:
1 - buy
2 - accumulate
3 - hold
Note: we are currently maintaining our 1H rating on Veritas ("VRTS") due to
the company's unique position in the storage market, the fact that it's very
under penetrated, and currently experiencing an increase in deal flow.
(Please refer to our recent notes on Veritas for more details.)
Valuations
----------
Although we recognize that much of the downside risk is already reflected in
current stock prices, we can not ignore looming fundamental erosion which has
been caused by an economic downturn.
Brocade: Price target to $44 from $56. We have applied a 55x multiple to our
forward EPS estimates one year out to arrive at our current price target.
EMC: Price target to $45 from $50. We have applied a 35x multiple to our
forward EPS estimates one year out to arrive at our current price target.
Inrange: Price target to $24 from $29. We have applied a 15x multiple to our
2001 revenue estimates to arrive at our current price target.
NetApp: Price target to $29 from $50. We have applied a 50x multiple to our
forward EPS estimates one year out to arrive at our current price target.
Numbers Revisions
-----------------
EMC: We are reducing our 2001 revenue estimate to $11,280 million,
representing 27.1% yoy growth, from $11,500 million. We are reducing our
2001 EPS estimates to $0.95, representing 19.2% yoy growth, from $0.96.
Brocade: We are reducing our F2001 revenue estimate to $667.5 million,
representing 102.9% yoy growth, from $711.3 million. Our updated calendar
2001 revenue estimate is $690.3 million, representing 68.1% yoy growth. We
are reducing our F2001 EPS estimates to $0.53, representing 90.6% yoy growth,
from $0.57. Our updated calendar 2001 EPS estimate is $0.55, representing
59.0% yoy growth.
NetApp: We are reducing our F2002 revenue estimate to $1,528.7 million,
representing 40.9% yoy growth, from $1,700.0 million. Our updated calendar
2001 revenue estimate is $1,358.6 million, representing 45.4% yoy growth. We
are reducing our F2002 EPS estimates to $0.51, representing 25.0% yoy growth,
from $0.55. Our updated calendar 2001 EPS estimate is $0.47, representing
34.9% yoy growth.
Note: We are not adjusting our current estimates for Inrange. We believe
Inrange's direct sales model is paying significant dividends in the current
downturn.
Overview
--------
We remain positive about the longer term growth prospects of the storage
industry. However, we are adjusting our ratings to more accurately reflect
the near term economic reality. We are taking our actions due to broader
economic weakness. Our ratings changes are not reflective of any company
specific issues. We continue to be very excited about the longer term growth
prospects of the industry, including both SAN and NAS, and believe that these
companies will be very well positioned to appreciate an economic recovery.
We believe that deteriorating economic conditions will continue to impact
storage companies' fundamentals in the upcoming months. We have continued to
see signs of building component inventory levels, pushed out new application
implementations, cancelled customer orders, lengthening sales cycles and
continued customer budget cuts. Further, we continue to hear feedback (over
the past couple of weeks) that international markets are slowing, which has
been a bastion on strength in the past few quarters.
Due to continued customer feedback, we now believe the storage market will
grow between 15-20% this year, which is down from prior expectations of 25%.
Note: we continue to believe the long term growth rate of the industry will
be around 25%.
In our opinion, many of our companies have been executing flawlessly and have
great management teams with a huge secular trend ahead. We continue to
believe that the trend to network storage is forthcoming and only just
beginning to unfold. We note that many of our companies' current pauses are
related to macroeconomic conditions, not poor execution.
We See These Companies Exiting The Pullback Even Stronger
---------------------------------------------------------
We expect Veritas and EMC to use this economic pullback as an opportunity to
gain significant market share (and we expect them to succeed). We believe
Veritas remains very under-penetrated and that EMC continues to lead the
(subsystem) pack by a wide margin.
We believe that Brocade will continue to add to its infrastructure and
migrate to a direct sales model quicker than previously anticipated. We
expect that this will be welcome news for OEMs, who could use the help and
are looking to focus more on hardware and software sales (i.e. servers and
storage). This will mean higher Average Selling Prices (ASPs) for Brocade
(OEMs generally get about 50% discounts), greater customer exposure and
higher margins.
We believe Inrange is experiencing solid growth in the market and is
establishing itself as a clear storage networking leader. In fact, we
believe its direct sales model is paying significant dividends in the current
market environment and expect Inrange to continue to gain market share at an
increasing rate throughout the downturn.
We believe NetApp will continue to aggressively invest in R&D. We expect to
see NetApp power into its next leg of growth (perhaps in the latter part of
the year) by delivering greater scalability through management functionality
and SAN support. We continue to believe that NetApp is the clear NAS leader
with excellent technology, but that it must deliver its next generation
technology, combined with a broader services offering, in order to gain
traction in enterprise accounts.
Observations
------------
*Storage industry growth in 2001 looks to be slowing to 15-20%, versus
earlier expectations and a longer term growth rate of 25%.
*Deals are getting bigger, which also means longer sales cycles.
*Large deals are requiring more signatures and top management is not signing
off, which means that many large deals are getting pushed out (we are not
seeing many outright cancellations).
*About 80% of storage spending is fixed (20% variable; variable example:
storage attached to new project implementations) and about another 10-15% can
get pushed out by expanding disk capacity behind controllers, allocating less
storage to applications (such as email, Word, Excel, etc.), and dipping into
non-production capacity (i.e. taking testing equipment and putting it into
production). Note: this jives with our industry growth expectations.
Negatives
---------
*IT managers are mentally not willing to spend.
*We are seeing a lot of IT managers clamping down on headcount, travel and
new purchases.
*Many IT departments are taking up their capacity utilization rates (for
example: using 60% of available storage capacity instead of 40% previously).
*International markets seem to be softening, this has been an area of
strength for many companies in the past few quarters.
Positives
---------
*The storage industry is on the cusp of an upgrade cycle (i.e. SAN & NAS)
which should provide an excellent leg of growth (i.e. new product cycle).
*More IT dollars are being spent on storage, currently at about 50% and
moving to about 75% of the server/PC/storage budget.
*Customers are pushing out purchases, which they must eventually buy. This
could be putting a demand surge in place for future growth.
QUARTERLY ESTIMATES PER SHARE DATA
Current Year* Next Year Next Year + 1
Ticker Period Current Previous Current Previous Current Previous
BRCD 1Q $0.13A $0.13A NA NA NA NA
2Q $0.12E $0.13E NA NA NA NA
3Q $0.13E $0.15E NA NA NA NA
4Q $0.14E $0.16E NA NA NA NA
Year $0.53E $0.57E NA NA NA NA
EMC 1Q $0.21E $0.21E NA NA NA NA
2Q $0.22E $0.22E NA NA NA NA
3Q $0.24E $0.26E NA NA NA NA
4Q $0.28E $0.28E NA NA NA NA
Year $0.95E $0.96E NA NA NA NA
INRG# 1Q $0.04E $0.04E NA NA NA NA
2Q $0.06E $0.06E NA NA NA NA
3Q $0.09E $0.09E NA NA NA NA
4Q $0.11E $0.11E NA NA NA NA
Year $0.30E $0.30E NA NA NA NA
NTAP 1Q $0.09A $0.09A $0.11E $0.12E NA NA
2Q $0.10A $0.10A $0.12E $0.13E NA NA
3Q $0.11A $0.11A $0.13E $0.14E NA NA
4Q $0.11E $0.11E $0.14E $0.16E NA NA
Year $0.41E $0.41E $0.51E $0.55E NA NA
Jack |
