The Cloud

NetApp Strives to Shed Hardware-only Image

The big data storage provider still sells mostly hardware but positions itself as a key player in a "hybrid cloud" world.
David McCannSeptember 26, 2018
NetApp Strives to Shed Hardware-only Image

In a world where, to the casual observer, all things technology seem to be moving to the cloud, NetApp is determinedly straddling both that world and its traditional hardware space.

Since well before CFO Ron Pasek joined the Fortune 500 data management company in April 2016, it has self-identified as a provider of “hybrid cloud” services. Yet even today, a large majority of its revenue derives from selling on-premises hardware for data storage.

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The term “hybrid cloud” relates to the fact that most large companies have data storage and computing capacity both on-premises and in public and/or private clouds. NetApp offers services that allow customers to move data back and forth among all of those environments and consistently manage data across them.

The company says its “Data Fabric” architecture “delivers consistent and integrated hybrid cloud data services for data visibility and insights, data access and control, and data protection and security.”

Ron Pasek

The company currently projects that its cloud business will grow to as much as $600 million within three years. For context, in its most recent fiscal year, which ended April 27, 2018, NetApp had total revenue of about 10 times that much — just over $5.9 billion.

The $600 million target “may not sound like a lot, but it’s a meaningful number,” Pasek tells CFO. “First, our cloud business has a very high, SaaS-like profit margin. Second, it’s recurring revenue — it happens every month, because it’s subscription based.”

Third, Pasek says, most people still think of NetApp as strictly a hardware company, “because anytime we sold our software it was on our hardware.”

However, the company is hip-deep in a different approach to software. That started in 2012, when it struck a deal with to provide not only storage capacity, but also its dominant storage operating and file systems, through the Amazon Web Services cloud platform.

NetApp followed up in 2017 and this year with similar deals providing access to those systems through the other two “hyperscale” cloud platforms, Microsoft Azure and Google Cloud Platform.

“If you’re on any of those platforms and need storage, you may not know it, but you’ll be pinging our [storage] service,” says Pasek. “And if you’re running our OS or [file] system on premises and want to run it in public clouds as well, we’ll provide it as a service. ”

The vision behind the hybrid cloud strategy rests on a belief that companies will continue indefinitely to locate some computing and storage capacity in on-premises hardware.

“The hyperscalers used to say that everything would move to the cloud,” Pasek says. “At the time I came to NetApp, there was an overarching fear in the storage industry that the cloud was going to kill it.”

By now, however, the hyperscalers “have come around to our way of thinking,” says the CFO. “We believe customers will forever operate in a hybrid cloud world. Different industries will be tilted one way or another, but all will have some amount of data both on-premises and in clouds.”

Forever is a long time, and it remains to be seen whether NetApp will one day be compelled to alter its long-term vision.

For now, regulations preclude companies in some industries, notably financial services, from keeping certain data anywhere but on-premises. More to the point, however, companies still tend to keep close highly confidential information, such as the “secret sauce” to its high-value intellectual property.

Will it be that way forever? Pasek acknowledges that even now, perceptions that public clouds are on average less secure than on-premises hardware are not necessarily accurate.

“It just depends on how each particular customer feels about it,” he says. “Many are simply not comfortable [with public clouds] yet, and they may never be.”

The good news is that the company’s financial results are trending solidly in the right direction, after it struggled during the early years of the transition to its new business model.

In fiscal-year 2018, NetApp revenue grew by 7% year-over-year. Operating income did better than that, up by 18% — a 7th consecutive quarter of growth.

Best of all was the company’s performance in earnings per share, aided by share buybacks. NetApp quantifies EPS by dividing “non-GAAP net income” by fully diluted shares.

The non-GAAP metric excludes, where applicable, amortization of intangible assets, stock-based compensation expense, litigation settlements, acquisition-related expenses, restructuring charges, asset impairments, gains/losses on sales of property, and GAAP tax provision.

The so-defined EPS shot up 27% in fiscal 2018, following a 27% jump the prior year. The skids are greased from continued EPS improvement, given the company’s recent authorization of a new $4 billion share-buyback program. That announcement followed immediately upon completion of a previous $2.58 billion buyback. And there appears to be plenty of room to push on with repurchases, given NetApp’s $22.4 billion market capitalization.

According to Pasek, the future is bright for bottom-line results as well, given the hybrid cloud strategy.

“If you look at both storage and compute, most of the growth is in the cloud,” he says. “But most estimates we see show that in four to five years that growth will slow, and the market for on-premises hardware and what’s available in the public clouds will be about equal. In other words, there’s still a very large available market to tap.”