Below the Radar: StorageTek Bets That Old Is Still Beautiful

With firms practically doubling their data-storage capacities every 12 months, it's no wonder that disk-storage companies such as EMC (EMC Quote) that provide high-speed access to stored information get the lion's share of attention among storage companies.

But some fund managers and analysts believe that this very explosion of data will continue to make tape storage -- a much older and slower method of accessing data -- necessary. Tape can take as long as two minutes to access, whereas data on disks can be accessed in one second or less. But tape's big advantage over disks is that it's far cheaper.

Gartner Group estimates that tape costs 1/50th the price of disk storage. And even with the cost of disk storage dropping 30% a year, many analysts believe that tape storage will continue to be relevant for many years to come.

A leader in the tape-storage business is Storage Technology(STK Quote). Also known as StorageTek, the company derives 54% of its revenue from tape-storage products, 40% from networking and servicing of tape and disk systems, and just 7% from disk-storage products.

StorageTek's Advantages

"While there's a lot of competition in the midrange of the tape market, StorageTek is a recognized leader in the high end of the market because they have a lot of experience and a good reputation," says David Hill, director of storage research at Aberdeen Group. "They also offer solutions that can span Windows, Unix and mainframe systems and are improving the throughput to tapes with a number of new technologies. They are to the tape business what EMC is to the disk business."

Kevin McCloskey, portfolio manager of the (FSTKX Quote)Federated Stock fund, which has 1% of its $1.6 billion of assets in StorageTek, says he invested in the company because a wide range of industries -- including medical and financial firms, as well as government agencies -- store vast amounts of less frequently used data on StorageTek tapes.

Tale of the Tape While volatile, StorageTek's stock is up 60% this year

Source: BigCharts.com

Although StorageTek fell 48.3% in 1999 and 51.2% in 2000, it's up 60% year to date. According to the company, sales were flat during those years due primarily to the loss of a marketing partnership with IBM(IBM Quote) in late 1998. IBM used to sell StorageTek disks as an original-equipment manufacturer, and those sales accounted for 20% of StorageTek's revenue in 1998, says Karla Kimrey, vice president of investor relations at StorageTek. When that relationship ended, the company's disk sales fell sharply because customers didn't recognize StorageTek as the manufacturer, Kimrey says.

The company continued to founder in 1999 and 2000, analysts say, until Patrick Martin became Storage Technology's new chairman and CEO last July and undertook a restructuring of the company to refocus on its tape, networking and service business, as well as to revamp the sales force.

Pointing to these changes, Glenn Hanus, an analyst at Needham & Co., says, "We believe that the odds favor slow, continuing improvement in STK's fundamentals over the next year." (Needham did some convertible debt and equity underwriting for StorageTek in 1993.)

Investors also point to a strong balance sheet at StorageTek. Shebly Seyrafi, an analyst at A.G. Edwards, which has not done any underwriting for the company, notes that StorageTek increased its cash holdings by $12 million in 2000 to $292 million and lowered its debt by $69 million, or 9.7%, to $646 million. "The company's debt/capital ratio improved to 7% in the first quarter, down from 9.3% in the prior quarter and 20.8% a year ago," Seyrafi says.

Balancing Its Books StorageTek has been using its extra cash to pay down debt over the past year

Source: Company filings

This strong balance sheet is one of the reasons Rikard Ekstrand, vice president and portfolio manager at First Pacific Advisors, has invested 4.88% of the $461 million of assets in (FPPTX Quote)FPA Capital in StorageTek.

"They have a clean balance sheet and are producing a lot of cash flow. Last year, they raised $2.60 in free-cash flow, which is all the cash being generated less capital expenditures, and that allowed them to pay down their debt," Ekstrand says. "This is something we spend a lot of time looking at because this is the cash available to investors."

Get It on Tape

Currently, it costs about 10 cents to store a megabyte, or 1 million bytes, on a disk, but only 0.2 cents to store a megabyte on tape, according to Gartner. So if a hospital wanted to store a terabyte, or 1 trillion bytes, of medical records, it would cost the hospital $100,000 to store that information on disk, but only $2,000 on tape.

Because storage needs are exploding and tape is an inexpensive way of storing or archiving less-frequently used data, analysts and fund managers believe that IT managers will continue to store at least part of their companies' data on tape. For instance, a phone company might store bills that are 3 months old or older on tape, says Bob Passmore, Gartner's director of storage research. A nuclear research institute generating dozens of terabytes of data each day might move that data to tape on a weekly basis. In both cases, it makes sense to archive the data on tape at some point, and this is true for the information being generated in every industry, Passmore says.

Although tape storage is only a small portion of the overall storage market, it's poised to grow nearly as rapidly as disk storage over the next two years, according to Bear Stearns. The investment banking firm, which has not done any underwriting for StorageTek, expects the overall storage market to grow from $65 billion in 2000 to $110 billion by 2003, for an average annual growth rate of 18% a year. Tape storage will grow from $2.5 billion in 2000 to $4 billion by 2003, for an average annual growth rate of 16% a year, Bear Stearns projects.

In terms of the total amount of data that companies around the globe will be storing, Bear estimates this will explode at an average annual compound rate of 76%. The only reason why the storage market itself won't parallel that growth is because the cost of storage is coming down, according to Bear. To quantify just how big this collection of stored data will be, Bear estimates that, globally, companies stored 0.7 exabytes in 2000 (1 exabyte is roughly 1 trillion terabytes). Bear expects the total amount of stored data to grow to 3.8 exabytes in 2003.

"Companies are configuring their storage in many advanced ways, but tape will continue to have a role for many years to come due to the fact that we are storing more and more stuff," says Joseph Butt, a senior analyst who specializes in e-business infrastructure at Forrester Research.

Gartner's Passmore agrees: "I've heard very powerful and famous people over the past 30 years pronounce that tape is dead, and it's still here and it's still as strong as ever, and I believe it will continue to be strong 10 years from now."