The Storage Bubble Is Soon to Burst
By MARK VEVERKA
April 22nd, 2002
Barrons Online
Two years ago, star venture capitalist Vinod Khosla publicly predicted that an optics bubble was nigh. There were hundreds of overvalued startups looking to capitalize on the telecom mania, and the Kleiner Perkins partner saw that the market could never absorb them all. Recent bankruptcy filings by Yipes and Global Crossing, which were thought to be exceedingly well-funded companies, are testimony to the crash of that once effervescent market.
We caught up with Khosla recently in Arizona, where over cereal and coffee, he told us he planned to make a similar prognostication about another bubbly sector: storage startups. Sure enough, Khosla gave a speech the next day at technology guru George Gilder's Storewidth Conference in southern California that foretold a similar fate for storage. We were unable to attend the presentation, but Darren Thomas, chief executive of one such startup, Zambeel, was on hand.
"Khosla's intent was to show that there simply are too many players in the space. There are a hundred and something storage companies," Thomas notes. "Clearly, there is a storage bubble, and it's a bubble because the space is hot."
The former head of Compaq Computer's highly regarded storage business, Thomas heads a company funded, in part, by Khosla. Zambeel has raised a hefty $65 million to date, much of it thanks to Thomas, who was aggressively recruited by Kleiner Perkins to run the firm. Thomas was attracted to the job because he anticipates that new storage hardware architecture is going to emerge sooner or later. Not surprisingly, he thinks Zambeel, which has developed technology for storage area networks, has a good shot at making that happen. Storage area networks give computers access to large numbers of data-storage systems and are deemed more efficient than traditional storage hardware.
In bringing attention to the bubble, Khosla also went on to explain why Zambeel and his other storage plays, amid hundreds of competitors, should survive the imminent shakeout. Of course, the venture investor probably would settle for a "liquidity event," be it a merger or an initial public offering, that at the very least would pay off investors, including himself.
As it turns out, Khosla's proclamation may have been more of a declaration than an earthmoving prognostication, protests Gary Bloom, chief executive of storage software maker Veritas Software.
"I predicted it during the last part of last year. We did our last venture investment during the latter half of last year," Bloom says. "Now we've seen all of the valuations fall. I just think he's a little late, because a lot of the air has already been let out."
Bloom, who oversaw venture investments at Oracle when he was the No. 3 executive there, said Veritas took a $16 million write-off in the third quarter of its last fiscal year for investment losses. He says the company's leavened venture portfolio is valued at about $20 million, a drop in the ocean for a company that boasts $1.9 billion in cash.
Says Bloom: "The real challenge for the start-ups is delivering the technology that they are all talking about."
The Truth Is Out There
Last week, Veritas announced it had beaten the Street's modified expectations for the second quarter, but shares plunged six bucks, to 31.50, after CEO Bloom gave analysts lower estimates for the second half of the year.
Enterprise software of many flavors, not just storage, is going though a transformation. Gone are the days of the mega-deal. Big deal flows have slowed, and customers are buying less in anticipation of future needs, Bloom says. Software makers must do a larger number of smaller deals to make their numbers.
Because most larger software sales are closed toward the end of a quarter, Veritas was surprised when a number of big customers cut their orders by more than a half when it came time to buy. Deals originally valued at $4 million were slashed to $750,000, and that didn't bode well for the rest of the year.
"These budgets were created during very difficult windows of economic data," Bloom says. "It's a more buy-as-you-go approach that customers are taking."
The good news for Veritas shareholders is that the company's small deal flow has been steady, and market share in recovery and back-up storage software has risen since Sept. 11. Look for Veritas to make news next week during its annual customer hoedown in Dallas, where the software maker plans to unveil a new line of products for IBM's Unix server platforms. As an "agnostic," or neutral, manufacturer, Veritas has provided software to most of the major storage hardware players, including industry leader EMC, Compaq, Hitachi Data Systems, and Hewlett-Packard. Until now, IBM has been a missing link in its product offerings.
As is often the case in cutthroat technology marketing wars, EMC apparently isn't thrilled with Veritas's new relationship with nemesis IBM. Thus, the folks from Hopkinton, Mass., have planned a counter-marketing announcement in Manhattan in attempt to steal some of Veritas' thunder.
As hardware becomes less relevant and more commoditized, Bloom says EMC will tout its shift into the higher margin storage-software business. "In a funny way, we like that they are trying to rain on our parade," Bloom says. "It is a very public acknowledgment that all of the value in the storage market is moving away from the hardware to the software."
To that point, EMC was subjected to some tough love last week from brokerage analyst Ashok Kumar of U.S. Bancorp Piper Jaffray. "We are not sure who the new king [of storage] is going to be, but it probably won't be EMC. They are today's re-enactment of the trains-to-planes evolution that happened in transportation 70 years ago," Kumar stated in a note. "The value they have in their systems will be replaced by more efficient, more valuable functions running in network boxes. EMC is still an extremely important and influential company, but their window to shift their business emphasis is closing," he wrote.
Wasn't it just yesterday that world-beating EMC couldn't be stopped?
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