Investing in Venture Capital Analog Stocks
Several network storage companies look attractive — 3Par Inc. (PAR) is my #1 pick.
Network Storage continues to attract venture capital investments, with 6 deals done over the last three months for $125 million in new capital. Since February of 2006, I have identified 25 VC deals in the Network Storage catagory, investing $420 million into private growth companies.
The venture capitalists are targeting the $21 billion storage hardware market — an attractive entrepreneurial endmarket because of its strong secular growth (about 8% per year) and rapid pace of technological change. Sizing the key target markets, we see $11 billion in FC SAN (fibre channel storage area network) revenues, $4 billion in NAS (network access storage) revenues, and $3 billion in iSCSI (IP-based SCSI connection) revenues. There is an additional $3 billion in DAS (direct access storage), offline tape backup, and virtual tape library revenues that are readily targetable by the storage hardware companies.
I actually like four of the five storage companies I analyzed, including (in order of attractiveness) 3Par Inc. (PAR), Compellent Technologies, Inc. (CML), EMC Corporation (EMC), and NetApp Inc. (NTAP) . 3Par is particularly attractive at the current price of $8.94.
The table below summarizes my valuation analysis for these five companies. Read further for the story behind the numbers.
|Company Name||Current Price||Target Date||# Years||5 Yr
|Tedâ€™s Buy Price||% Move to Buy Price|
|3PAR Inc. (PAR)||$8.94||Mar, 2013||4.9 yrs||$33||30.8%||20.0%||$14||+53%|
|CompellentÂ (CML)||$11.87||Dec, 2012||4.7 yrs||$31||22.5%||20.0%||$13||+10%|
|EMC Corp. (EMC)||$16.10||Dec, 2012||4.7 yrs||$28||12.3%||10.0%||$18||+10%|
|NetApp (NTAP)||$24.87||Apr, 2013||5.0 yrs||$54||16.9%||15.0%||$27||+8%|
|Isilon (ISLN)||$4.82||Dec, 2012||4.7 yrs||$7||8.3%||20.0%||$3||-38%|
View the spreadsheet used for the income statements, valuation analysis, and buy targets shown above.
3Par posted $94 million in revenues during calendar 2007, and my model has them delivering over $460 million in revenues in five years. That’s a compound annual growth rate of 33%, and it has 3Par taking a hefty chunk of the $11 billion FC SAN (fibre channel storage area network) market. 3Par has a good chance of pulling off this kind of revenue growth because their product is targeted at the virtualization breakthrough shaking up data centers worldwide.
3Par makes what they call, “utility storage,” storage arrays that are built specifically for utility computing. “Organizations use utility computing to build cost-effective virtualized IT infrastructures for flexible workload consolidation. Next-generation storage is a category of arrays developed to address the limitations of traditional storage arrays and meet the needs of virtualized infrastructures.”
Moving to a virtualized server environment is extremely compelling for corporate data centers. In a case study of British Telecom, for example, 1,356 physical servers were consolidated to 102 with a power savings of around one megawatt, a space savings of 293 racks, and a reduction in the number of ports utilized by 4,000. Put another way, moving to a virtualized server environment reduced BT’s data center footprint by over 90%. There’s big savings to be had here.
A virtualized server environment often goes hand-in-hand with an initiative in networked storage. One consultancy found that 70% of the companies adopting virtualized servers also buy new network storage, increasing their average storage usage by 23% over the following 18 months.
The decision regarding what storage vendor to use is made based on a number of factors, including performance, cost, complexity (simpler the better), and disk-saving features such as thin provisioning and data deduplication. 3Par is clearly winning their share of RFPs — 3Par’s revenues grew 74% this year and 74% last year. My 5 year projection of 32% annualized is in line with consensus analyst expectations. I suspect that 3Par’s concept of “utility storage” is particularly attractive to an IT consultant looking to add efficient storage to the new virtualized data center they are being paid to implement.
Here are the assumptions I made in developing my $33 five year target for 3Par:
My $14 buy limit on PAR (current price $9) is based on discounting the $33 back on a 20% annualized internal rate of return. This 20% represents the internal rate of return that I want before I take on the risk of owning 3Par. That is a high internal rate of return — I have included a table in the spreadsheet above that allows the reader to look up their own current fair value given a series of annualized internal rates of return.
The Compellent Technologies story is similar to 3Par, in that Compellent is also targeting the $11 billion FC SAN market. There are some differences, however. While 3Par focuses on “utility storage” and the implementation of the virtualized data center, Compellent markets more aggressively to the SMB (small and medium sized business) market.
For me, Compellent’s marketing literature makes for easier reading than 3Par. I feel that I could literally buy a set of Compellent storage and implement all these new fangled concepts myself. This is good marketing, and it perhaps explains Compellent’s higher valuation in the stock market (CML is 6.1 times trailing sales, while PAR is 4.7 times trailing sales).
One industry review gushes to the extent that you wonder if the guy received a thank you note in the form of stock certificates from the company:
So, CML’s marketing is good, and they have been growing even faster than 3Par — CML’s revenues were up 120% in 2007 and up 135% in 2006. The March quarter just reported showed revenue growth at a 107% pace. My five year expected annualized growth of 36% is in line with consensus expectations, and it drives Compellent’s revenues to $258 million by the end of 2012 (up from $60 million in trailing four quarter revenues).
The only yellow flag I see in the Compellent income statements is that R&D spending is 28% of 3Par’s level, while revenues are 55%. How can Compellent, a very comparable story with an even broader set of software features, get away with half as much proportionate research and development dollars spent? I don’t know the answer.
Despite this, I do believe Compellent Technologies is attractive at the current price of $11.87. I would buy CML up to $13, with a five year target price of $31.
EMC faces several challenges to their network storage market share over the next couple of years. 3Par, Compellent and NetApp are expected to take some portion of the FC SAN market, as the marketing materials from all three of these smaller competitors delight in detailing their cost and performance advantages over the market leader. On the iSCSI front, Dell Computer’s (DELL) purchase of Equallogic in November of 2007 will hurt EMC’s Clarion revenues — some analysts say that Dell accounted for 35% of EMC’s Clarion storage revenues in 2007.
EMC, however, is doing some things very well.
VMWare is not overvalued here at $68, in my opinion. Consulting firms are expecting server virtualization revenues to continue growing at a 100% pace. Expanding VMWare’s 2007 revenues of $1.3 billion at 45% per year over the next five years gives you a 2012 revenue forecast of $8.6 billion for VMWare. With a 5x multiple on those revenues (VMW has 88% gross margins!), you get a 10% per year annualized internal rate of return on VMWare’s price from current levels. To me, VMWare is currently fairly valued on conservative assumptions.
Valuing the non-VMWare (NAS and FC SAN) portion of EMC is more difficult. EMC’s network storage market share is under attack, no doubt. Having said that, the non-VMWare business is profitable (54% gross margins) and surely worth more than the 0.97 times sales we arrive at after stripping out VMWare.
Using a breakup value, EMC is clearly worth more than it is currently selling at.
With the more traditional analysis I go through in the spreadsheet above, using five year projections of earnings and revenues, I arrive at $28 in long term value for EMC. I would buy EMC up to $18 per share (current price is $16.10).
The growth story at NetApp is driven by the continuing — and possibly accelerating — adoption of NAS and iSCSI storage. As ethernet transport gets faster, the speed advantage of a fibre channel connection into a storage area network is reduced. Right now, the speed of a fibre channel connection is 4G. Ethernet speeds are all over the map, ranging from the 100M through the port in my 10 year old Cisco router to legitimate 10G speeds being delivered today over copper wire in test settings.
Its fair to say that there will be a continued shift from FC SAN to ethernet (NAS and iSCSI) storage over the next several years. IDC is forecasting a move from 27% market share to 46% market share for ethernet storage from 2007 to 2011. As the global leader in ethernet storage (as opposed to a distant second in FC SAN), this market shift should benefit NetApp.
Here are the assumptions I made in developing my $54 five year target for NTAP:
I have discounted the $54 long term target price back at a 15% internal rate of return to arrive at a current value of $27. Accordingly, I would buy NetApp for up to $27 (8% above Friday’s close of $24.87).
Isilon Systems, Inc. (ISLN) is unattractive to me because I don’t see them breaking even over the next five years. Their operating margins and revenue growth are lower than Compellent and 3Par, for example. Also, Isilon has a more difficult competitive position than Compellent and 3Par, because Isilon is going up against NetApp’s core strength in the NAS and iSCSI markets.
The market statistics presented byNetApp in their March, 2008 analyst presentation are a helpful guide to understanding the opportunities in this sector. NetApp combined research from Forrester, Gartner and IDC to arrive at the following market view for worldwide storage revenues in 2009. This includes storage hardware, storage software and storage services.
|World Wide Storage Market Projection for 2009||Global Storage Market||NetApp Target Market|
|Â Â Â FC SAN (Fibre Channel Storage Area Network)||$11 b||$11 b|
|Â Â Â DAS and ESCON (Direct Access Storage and Enterprise System Connection)||$5 b||$1 b|
|Â Â Â Networking||$4 b||$0 b|
|Â Â Â NAS (Network Access Storage)||$4 b||$4 b|
|Â Â Â iSCSI (IP-based SCSI Connection)||$3 b||$3 b|
|Â Â Â Offline (Tape Backup)||$3 b||$1 b|
|Â Â Â Open Systems VTL (Virtual Tape Library)||$1 b||$1 b|
|Subtotal Storage Hardware||$31 b||$21 b|
|Â Â Â Storage Software||$14 b||$7.7 b|
|Â Â Â Enterprise Content Management||$6 b||$0 b|
|Â Â Â Security Software||$3 b||$0.3 b|
|Subtotal Storage Software||$23 b||$8 b|
|Â Â Â Hardware and Software Support||$14 b||$11 b|
|Â Â Â Consulting and Integration||$9 b||$2 b|
|Â Â Â Hosting and Operations||$7 b||$0 b|
|Subtotal Storage Services||$30 b||$13 b|
|TOTAL 2009 STORAGE MARKET||$84 b||$42 b|