Disaster-Recovery Needs Didn't Stop Storage's Slide

In theory, it made all kinds of sense that companies would load up on storage capacity in the wake of Sept. 11, investing in disaster recovery to protect themselves in case of future attacks.

But in practice, that idea proved a bust.

Granted, the terrorist attacks drove home the point that companies needed to be better prepared for disasters. But they also struck such a body blow to business confidence -- in an already sluggish economy -- that nervous managements grew leery of spending on expensive goods like storage systems.

After Sept. 11, IT managers "basically got risk-averse and said, 'Let's hold back on the big expensive projects a bit,' " says Michael Kelly, chairman of Techtel.com, which conducts surveys on corporate technology spending habits.

As a result of the weak macroeconomy, in 2002 leading storage stocks have slowly deflated to below the depressed levels they reached in the immediate wake of the terrorist attacks. After initially staging a recovery around the end of 2001 -- when the broader market rebounded from the attacks -- storage concerns have surrendered that ground, and more, on concerns about weak corporate spending.

As of early September, EMC(EMC Quote - Cramer on EMC - Stock Picks) and Veritas(VRTS Quote - Cramer on VRTS - Stock Picks) were trading below their post-Sept. 11 lows, while Network Appliance(NTAP Quote - Cramer on NTAP - Stock Picks) came uncomfortably close to its low during August.

A Retrospective on Storage

Some market watchers had initially predicted that storage could see a bounce in the wake of the terrorist attacks. "It seems plausible that companies throughout the world will assess their own backup and contingency systems, which could lead to increased purchases, and a recovery in the corporate 'enterprise' technology sectors," said a report from Crowell, Weedon & Co. issued three days after the attacks last year.

Likewise, at the end of September 2001, U.S. Bancorp analyst Ashok Kumar suggested in a note that "as companies come to terms with the possibility that their own business has an element of risk exposure to terrorist acts, they will increase the spending on disaster tolerant systems, network and storage."

But Kumar also correctly predicted that growing competition and weak IT spending would outweigh any gains in disaster recovery sales.

Our Sept. 11 Home Page

Editor's Note: TheStreet.com Revisits Sept. 11

The Making of a Hawk by James J. Cramer

What We Saw the Day Time Stood Still

Investors Will Lose at Patriot Games

Amid the Smoke, Repacking Wall Street's Data Pipe

Document Chaos Isn't Sorted Out

Battle Against Terrorism Boosts Defense Sector

Faint Glow Alights on a Once-Ashen Wall Street

Disaster Recovery Needs Didn't Stop Storage's Slide

Security Software Gets Mind Share, but Not Sales

Lodging Woes Linger in Troubled Times

Market's Terror Trend Plays Out Predictably

Bankrupt Ricochet Rises Like a Phoenix After Sept. 11

Airline Woes Preceded Sept. 11 and Will Remain

Wall Street Shocked Into Exodus

In fact, that's what happened. The effects of the terrorist attacks only worsened matters, further slowing demand within an industry that was already suffering from a glut in capacity. "There was a lot of excess capacity storage out there and a lot of what I call gray market," explains Punk Ziegel analyst Steve Berg. "Companies were going out of business that had just bought new storage. It was not even used yet, and other companies were picking that up. Or, companies were closing down department X and saying, 'We can use that storage capacity in other departments.' "

As a result of the dropoff in demand, as well as new competition from players such as IBM (IBM Quote - Cramer on IBM - Stock Picks) and Hitachi, prices fell sharply across the storage sector. Between 2000 and 2001, the cost of one megabyte of storage dove from 17.3 cents to 7.6 cents, says Berg.

According to IDC, the storage market shrank nearly 19% in the same period, from $29.7 billion to an estimated $24.2 billion.

In its annual report, leading storage vendor EMC blamed the terrorist attacks for exacerbating the economic slowdown. In the wake of Sept. 11, potential customers cut back further on IT spending, which hurt sales, the company said.

In calendar year 2001, its revenue slid 20% from their 2000 levels, and it was forced to cut 4,000 employees.

Disaster Recovery Helps, But Not Enough

But though economic fallout from the attacks further depressed overall storage spending, anecdotal evidence suggests some companies were more inclined to invest in high-tech data backup systems.

Indeed, early in 2002, EMC CEO Joe Tucci listed "business continuity" equipment and services (in other words, fancy disaster recovery systems) as one of the five areas that would help drive EMC's growth through the year.

"Spending on business continuity has not been impacted as much as other areas of storage," explains EMC spokesman Greg Eden. The company doesn't break out the sale of products that might be used for those purposes. But they might include networked storage and services, as well as replication software to make high-fidelity copies of data.

Even now, the No. 1 reason companies buy storage is for disaster recovery, according to a recent survey of about 500 technology decision-makers by Punk Ziegel. In the survey, 19% of corporate respondents cited disaster recovery as the reason they wanted storage, ahead of the 17% who wanted faster access to data and the 15% who sought to keep better track of expanding customer rolls (respondents could choose more than one reason).

"It's become something that's definitely come to the forefront of every IT decision-maker's mind," says Suresh Vasudevan, director of software product marketing at Network Appliance, which sells network-attached storage.

In past conversations with customers, "disaster recovery may or may not have been brought up as part of the decision-making process. Now I find it very rare to have a conversation where disaster recovery is not one of the key purchase criteria," says Vasudevan.

But ultimately, the heightened interest in data security doesn't seem to have helped the bottom line much for storage companies.

Case in point: Earlier this year, storage software maker Veritas reported that its disaster recovery seminars were drawing standing-room only crowds of 300 to 400 people since Sept. 11, compared to 75 people before the terrorist attacks.

But those crowds haven't necessarily translated into sales, and Veritas has been missing numbers, notes Prudential Securities analyst John McPeake. The company's guidance for the current and past quarter has fallen short of Wall Street estimates.

In sum, "any increases in disaster recovery were certainly not enough to offset the decline in the entire storage industry," says Eric Sheppard, a senior research analyst at IDC.

In the meantime, surveys of IT officers suggest that spending on storage isn't likely to see any near-term pickup. "It looks as if we've just returned to a flat level indicating it's basically following along with the general trend from the economy," says Techtel.com's Kelly. "That's more of a factor right now than the terrorism. Nothing we can see says there will be a big bounce yet, though nothing says the bottom will drop out either. Things are basically just hanging in there, staying flat."