NetApp Building Cloud, Storage Capabilities, Value

NEW YORK (TheStreet) -- There's often no prestige in being considered second best at what you do. But when your current market is expected to grow in demand by close to 200% over the next three years, "prestige" becomes overrated pretty quickly. This makes the prospects of NetApp (NTAP) all the more interesting.

While this company plays second fiddle to market leader EMC ( EMC) in the realm of enterprise data storage and overall "Big Data", NetApp has been steadily building its storage/cloud capabilities while others such as IBM ( IBM) and Hewlett-Packard ( HPQ) have fallen off the grid. This means astute investors can still do well with second place. And if my suspicions are correct, the implications of "No. 2" may not matter for very long.

Revenue was up 1% in the most recent quarter, while growing 5% sequentially. While that wasn't up to the company's usual standard, it was still enough beat the low-end of management's guidance. Besides, NetApp wasn't significantly outperformed by EMC, which posted growth of only 3%. Product revenue was unusually weak, though -- falling 2% year over year. But this was offset by a better performance in service revenue, which grew 8%.

Also, to keep things in the proper perspective, HP's overall storage business, which consists of both converged and traditional storage, lost 13% year over year. But NetApp left no questions in terms of profitability. With the help of an improved product mix, non-GAAP gross margins advanced 170 basis points year over year to 60.1%, which led to a 4% increase in net income to $253 million.

This tells me that management has figured out ways to drive gross-margin expansion with a richer mix of products, which continues to accelerate cash flow. And as noted above, this is likely just the beginning of NetApp's growth, especially since the total available market for "Big Data" is projected to grow by as much as $17 billion over the next three years. The current market now stands at $6 billion.

To that end, fiscal 2014 first-quarter guidance seemed a tad conservative. Management expects revenue in the range of $1.47 billion to $1.57 billion, which suggests year-over-year growth of just 5.6%. NetApp expects non-GAAP gross margin to be up 1% sequentially, while non-GAAP operating margin is projected in the range of 13.5% to 14.0%, up 1.5% to 2% sequentially.

The conservatism in managements guidance tells me that NetApp doesn't expects enterprise spending to pick up much in the second half of the year, which goes against the optimism that another enterprise titan like Cisco ( CSCO) demonstrated in its recent quarter, during which CEO John Chambers spoke favorably about an imminent IT recovery.

Chambers understands that CIOs can't starve their businesses forever -- not if they want to compete effectively. The fact that both NetApp and EMC are growing at the rate in which they are despite the current weakness in IT spending suggests that enterprises have no interest in keeping up with their own data storage.

Given NetApp's strong showing in its fabric-attached storage and E-series line of products, the company's excellent strategy and design is begin to appeal more to its customers. But I also believe that the strength of NetApp's assets will soon begin to appeal to Cisco as an acquisition candidate, especially given NetApp's strong cash flow performance, which helped the company's 25% sequential jump in cash, which ended the quarter at $455.6 million.

Cisco, which has been shoring up its enterprise/cloud capabilities with recent acquisitions such as Cariden, Meraki and Intucell, which focuses on efficient data delivery, could really benefit from NetApp's industry-leading flash portfolio storage architecture.

What's more, given NetApp's recent partnerships with industry leaders such as VMware ( VMW) and SAP ( SAP), there are now plenty more reasons for Cisco, which has $47 billion in cash to start thinking about NetApp, which has a market cap of less than $14 billion.

For now, though, NetApp is operating with long-term shareholder value as its main objective. The company announced that it will increase its current stock buyback program by an additional $1.6 billion, which means that the company plans to buyback approximately $2 billion worth of its common stock during the course of the next 12 months. This is while management also kicked off a dividend payout of 15 cents per share, the first of which will be paid next month.

While shareholders will certainly welcome management's generosity, there's also the unintended perception that NetApp has reached a certain maturity status and is no longer growing. I do wonder, though, if management's decision to return all of this cash is as effective as if the company opted to spend that capital to compete and grow its capabilities.

Nevertheless, with the cloud market expected to grow to $177 billion over the next three years, NetApp, as the second leading storage company, is expected to see a significant chunk of this business. That along with the capital returned to shareholders, the potential value in this investments seems second to none.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Saintvilus is a private investor with an information technology and engineering background and the founder and producer of the investor Web site Saint's Sense. He has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.

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