When NetApp bought LSI’s Engenio division, many questioned the merits of the move. After all, NetApp is the poster child for unified storage and has built a multi-billion dollar business around WAFL, the Write Anywhere File Layout. NetApp’s entire storage portfolio revolves around WAFL and ONTAP, its core operating system and this has allowed the company to differentiate from the likes of EMC, HP and IBM which have highly fragmented portfolios. NetApp was the first company to market the benefits of unified block and file storage and virtually every major player in the business has copied its playbook there. NetApp recently acquired Bycast, a specialist in object storage and one would presume it will add object to ONTAP as well, creating the world’s single most comprehensive and versatile storage platform.
In some ways, NetApp’s greatest strength is its biggest weakness. Specifically, its unified approach brings simplicity but it doesn’t scale. This issue specifically and the tradeoffs of log structured file systems in general have been points of contention over at Wikibon and have been discussed in the community at length. NetApp’s attempts to integrate Spinnaker through a 2003 acquisition have been frustratingly slow for the company and startup Avere, formed by former Spinnaker execs, is aiming directly at the NetApp scaling problem and the new kids seems to be getting meaningful traction in the market. As you can see by the comments in the Wikibon discussion this issue upsets NetApp advocates but you can’t ignore the substantial evidence from user discussions that confirm that scale is not the primary value proposition for NetApp buyers.
So when NetApp bought LSI’s Engenio division for just under $500M recently many (including myself) assumed that this was a recognition that WAFL doesn’t scale. But NetApp is very clearly positioning Engenio as a rich media play– going hard after video and certain high performance markets. Is this a ruse, much in the same way that IBM announced when it bought XIV that it was positioning the product for Web 2.0? I don’t think so. IBM doesn’t know how to market storage and it’s lame attempt to tie XIV to the red hot Web 2.0 market of early 2008 was transparently silly even at the time. No, rather I think NetApp is very serious about emerging video markets and the potential for Engenio to play there. NetApp is great at understanding markets and clearly positioning products so I believe there’s real merit to its positioning of Engenio. NetApp is also stubborn and its invested so much sweat in the Spinnaker integration that it will try to see that through. And if that doesn’t come together it can always buy Avere.
The Financial Angle
NetApp senior management is very savvy and committed to its DNA as a focused storage player. So it wouldn’t do a transaction of the size of Engenio just for the financial hit. There has to be a strategic reason and rich media is going to drive an enormous amount of storage consumption. But the acquisition of Engenio is extremely attractive financially for investors and represents in my mind a pivotal point in NetApp’s history. Specifically, it needs to build a track record of successful acquisitions in order to continue its growth and remain independent.
NetApp’s acquisition history has been active but largely uneventful. Unlike EMC, which has transformed itself through acquisitions such as Data General and VMware, NetApp has been defined by almost purely organic growth. It’s acquisitions (e.g. Spinnaker, Decru, Onaro, Bycast, Akorri) have hardly been visible to the outside world. Engenio has the potential to be both incremental and at least semi-transformative by allowing NetApp to break serious ground in the emerging rich media market.
And from a financial perspective, the acquisition could be meaningful. The reason is that because of its high growth, NetApp’s valuation is substantially higher (on a revenue multiple basis) than most storage companies. EMC (because of VMWare) enjoys this dynamic as does Oracle (because it’s mostly a software company with higher multiples). HP, which trades at less than 1X revenue does not. For example, Oracle bought Sun for $0.70 on the dollar (net of cash) and the day it completed the transaction, Sun’s $7B revenue became worth more than $30B to Oracle’s shareholders when measured in valuation terms.
The same thing is happening here (albeit on a smaller scale) with NetApp’s acquisition of Engenio. The math is dead simple. NetApp is paying $480M for a company with about $700M in revenue. Assuming NetApp maintains the revenue stream, the value of Engenio revenue when merged with NetApp will be about $2.6B (see chart). For NetApp shareholders that means just over a $2B net gain in valuation terms. No brainer.
Now of course this assumes: 1) NetApp will continue to trade at its current multiple and 2) that it can maintain the Engenio revenue stream. My bet is 1) NetApp is underexposed to the broader market and will continue to grow faster than its competitors and 2) it will actually grow the Engenio revenue over time. Combined, assuming broader stock market fundamentals continue, this acquisition is an exceedingly good deal for NetApp shareholders. Even if revenue dips, NetApp’s valuation drops a bit and the market pulls back – this still means a huge win for NetApp shareholders.
Bottom line is that NetApp continues to impress with its growth and smart business moves and with some good manuevering can get big enough to make itself acquisition proof.