2 Cloud Leaders to Buy Today
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Unless you have been living under a rock for the last few years, I'm sure “the cloud” or “cloud computing” is something you've heard about. In simplest terms, cloud computing simply means allowing a user to run a program, access a file, or do other tasks without having those items installed directly on the user's hard drive. You can see how this would be an attractive option, and more and more companies are moving to the cloud. As an investor, how do you benefit? The first thing I did was to run a screen on the Fool.com CAPS Screener for computer hardware companies. While the cloud means storage not on your computer, someone else still has to store the information. The two brightest stars this screen turned up were EMC Corporation (NYSE: EMC) and NetApp (NASDAQ: NTAP).
The Competitive Landscape:
When it comes to the cloud, there are two main pieces that are selling points for businesses. First, offsite cloud storage is a key piece of the puzzle since all of the company's data has to be stored somewhere. Second, the software solution needs to be simple enough to use for the business to implement the switch to the cloud. While EMC and NetApp are arguably the co-leaders in this field, other companies are vying for position as well. For instance, the beleaguered Hewlett-Packard (NYSE: HPQ) and Dell (NASDAQ: DELL) both have their eye on storage, servers, services, and networking as future growth drivers. The CEO of Dell, Michael Dell has said on multiple occasions that he sees these areas as the future for his company.
Dell's recent acquisition of Quest Software for $2.4 billion was just another step for the company trying to transform itself into a software and services company. Dell seems to be moving in the right direction but represents a small threat to the co-leaders based on market share. In fact, software and storage only represented 19% of Dell's total revenue last quarter, and both showed sales down on a year-over-year basis. Dell also only holds about 1.2% of the storage market. Hewlett-Packard is also aiming for more sales in storage, servers, and networking, but the company is in even worse shape than Dell. Analysts are calling for just 1.75% EPS growth in the next few years, and next year's EPS is expected to decline.
Hewlett-Packard is a situation where the company's goals and aspirations don't line up with its results. In the most recent quarter, HP saw only a 6% increase in networking sales, but sales of servers and storage both declined. While HP holds a bit more of the storage market (at 1.7%) compared to Dell, the company's storage growth rate is the slowest of the four companies we have mentioned. The problem that Dell and Hewlett-Packard both face is that they have huge PC divisions that are declining. Unless each of these companies decides to spin-off or sell their PC operations, this will continue to drag on their results. The co-leaders in EMC and NetApp do not face this issue. Both companies are storage and software businesses, they stick to what they know, and are expected to grow much faster than their PC laden brethren.
EMC has two competitive advantages that allow the company to be one of the leaders in the move towards cloud computing. First, the company is the leader in attached storage and also reports the highest growth rate in this segment. Second, the company owns 80% of VMWare, which is a fast growing virtualization company. EMC can offer combined storage and software solutions to businesses, and clearly companies like what they are seeing. In the last three years, the company's net income has jumped over 125%, and analysts see over 14% EPS growth going forward. What is really amazing is how little investors are paying for EMC when you consider the value of their VMWare investment plus their cash and investments. At last count, EMC shows almost $11 billion in cash and investments, and the value of their VMWare investment at current market prices is about $28 billion. EMC's market cap of about $52 billion already has $39 billion of this value built in through VMWare and cash on the balance sheet. While VMWare's results are included in EMC's earnings, for a stock like this to trade for about 14 times projected 2012 earnings seems like a steal to me.
NetApp offers similar products and services to EMC and falls right behind the storage leader. In fact, in a study by Gartner EMC placed first with 41.7% market share versus 36% market share at NetApp. While NetApp hasn’t been growing quite as fast as EMC, there seems to be opportunity here. In the last three years, the company saw net income grow by over 50% in total, and operating cash flow followed with a 50% increase. In addition, NetApp is expected to grow earnings by about 12.3% in the next five years, and based on prior performance the company might do better. In the last four quarters, the company has beaten earnings estimates by an average of 5.5%. Maybe the most important part of the NetApp story is their cash and investments, which at last count totaled about $5.44 billion. Considering the company's total market cap is just $10.84 billion, this means investors are buying NetApp's business for fifty cents on the dollar. This type of discount to cash and investments might make some sense if the company was burning through cash, but NetApp is doing just the opposite. In the last four quarters, the company has actually generated about $270 million in free cash flow per quarter. The company is only going to add to its cash and investments if this keeps up and, given their strong market share, could make an attractive takeover candidate.
Investors looking for a play on the continued move towards cloud technologies would do well to start with NetApp. The company might be in second place when it comes to storage, but their cash position means investors should start their research here first. EMC offers an attractive investment option as well, as it seems the market is undervaluing the company's ownership in VMWare. Use this information as a starting point for your own research and see if either company can help your portfolio soar to the clouds.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Dell and EMC. Motley Fool newsletter services recommend Dell. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.