From 'RedHerring.com':
Fish or Cut Bait: Put your dollars into storage
By Paul R. La Monica
Redherring.com, September 25, 2000
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The winner of the great storage standards war is the subject of much debate on Wall Street these days.
In one corner, we have EMC (NYSE: EMC), the reigning champion of the storage market. EMC has been supremely successful selling high-end storage devices based on the storage area networks (SAN) standard. In the other corner, the challenger: Network Appliance (Nasdaq: NTAP), jabbing its larger rival with the SAN palindrome, NAS (network attached storage). Much has been made about whether NAS is the type of disruptive technology that will eventually supplant SAN. Simply put, NAS allows data to be stored on a local-area network, so its devices tend to be smaller and less expensive than EMC's SAN storage devices.
Long-term investors looking at the storage sector would be unwise to get too caught up in this technological rhetoric. In fact, I'd recommend that investors simply ignore the chitchat about which standard is going to emerge victorious. It's a little misleading to think that EMC and Network Appliance are engaged in a winner-take-all fight for Corporate America's IT dollars. This isn't "Gladiator."
In fact, some argue that the two technologies are actually more complementary than competitive. "I don't view them as competing. It's more Wall Street than anything else trying to drive the debate," says Greg Reyes, CEO of Brocade Communications Systems (Nasdaq: BRCD), a maker of Fibre Channel switches and software for storage vendors that does business with both EMC and Network Appliance.
SAN OR NAS? WHO CARES?
Focus on the macro trends. Ignore the notion that "There can be only one." (The first reader to email me with the movie I just referred to will be the recipient of gushing praise and adulation in my next column.)
The important question for investors, then, isn't who will win the SAN vs. NAS storage death match. It's whether EMC and Network Appliance are good buys right now. The market, after all, has caught on to the fact that storage is big business. EMC is up nearly 90 percent this year and trades at 103 times 2001 earnings estimates, while Network Appliance has skyrocketed 240 percent and trades at a multiple of 355 times 2001 estimates.
The fundamentalist in me cringes at the thought of recommending stocks this expensive, but I think these are still compelling values, because the market opportunity for storage is staggering. Why? It's the data, stupid. As the quantity and type of files continue to increase, so does the need to store it all. Just think about the number of Powerpoint presentations, digital photos, and multimedia files that are created and emailed back and forth every day.
According to estimates from IDC, the storage market could be worth $46 billion by 2003. And Forrester Research predicts that by 2003 corporations will be spending three quarters of their IT dollars on storage. It's no wonder that big server companies like Sun Microsystems, IBM, Dell, Compaq, and Hewlett-Packard have been squawking rather loudly about their latest storage initiatives.
NO JIHAD FOR EMC OR NETWORK APPLIANCE
Now, one could argue that competition from heavyweights like Sun, Compaq, and IBM could wind up cutting into the revenue and earnings for EMC and Network Appliance. But I don't buy that. Because EMC and Network Appliance are storage companies first and foremost, they don't have to get caught up in worrying about different server platforms and whether it makes strategic sense to sell storage products to bitter rivals.
As Mark Santora, Network Appliance's senior vice president of marketing, says, "Do you think [Sun CEO] Scott McNealy gets up in the morning and says 'I want to sell storage for NT servers'? Sun always has to be about Solaris and Unix. Regardless of what platform you're on, we don't care. We're not in a religious war here."
You could also argue that, since this spring's market shakeout, the tech stock landscape has become littered with the bones of unprofitable Internet companies. In fact, things haven't changed that much. For the last few years, the best performing tech stocks have been largely the blue-chip tech companies, market leaders with megabillion-dollar market caps. This is in part due to momentum, but it's not just irrational buying.
And in a market nervous about issues ranging from high oil prices to slowing profit growth, the companies that have continued to do well are the ones that have not posted disappointing results. Even if these stocks are trading at what seem to be absurd prices based on conventional valuation methods, what's the alternative? Should we buy low price-to-earnings ratio tech stocks that have fallen due to earnings warnings? Behold the power of momentum. Either jump on board the freight train or get the hell out of the way.
INCREDIBLY STRONG FUNDAMENTALS
EMC and Network Appliance have certainly benefited from the fact that storage, along with optical networking, is a prominent buzzword on Wall Street. But these are not companies that merely have the potential to generate strong revenue and earnings growth. They have been doing so for the last few years and appear to be on target to continue doing so.
EMC's revenue has increased at a 37 percent clip over the last three years, and Network Appliance's has increased at a mind-blowing 71 percent. Earnings for EMC have grown at an average of 45 percent, while Network Appliance has posted growth of 61 percent over the same time period. Looking forward, analysts are projecting long-term earnings growth of 30 percent for EMC and 60 percent for Network Appliance.
And while estimates for some tech companies have come down lately due to earnings warnings, analysts have been busy raising their numbers for EMC and Network Appliance. According to data from Baseline, the consensus estimate for EMC's 2000 earnings has increased by 3.5 percent over the last three months, while analysts ratcheted up their estimate for Network Appliance 10.4 percent.
It's certainly a bit unnerving to recommend stocks that are so close to their 52-week highs. But I'm supremely comfortable saying that these are two solid long-term bets in a sector that doesn't appear to be anywhere close to maturation. The biggest mistake investors (and the media) make is to say that because a stock has gone up a certain percentage, it must be ripe for a fall.
Cisco soared more than 1,400 percent in its first three years as a public company. Was it overvalued then? The market must not have thought so, as the stock has gone up another 5,400 percent since 1993. As long as the demand for storage continues to explode, I see no reason why EMC or Network Appliance can't keep growing at a pace healthy enough to satisfy long-term investors and the momentum crowd.
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