FalconStor Software

To be or not to be a virtualization company -- that's the question FalconStor Software Inc. (Nasdaq: FALC) was facing.

With virtualization not panning out to be the hot new category everyone expected it to be, companies like FalconStor have been struggling to shake free from the now-stale buzzword and pitch themselves as providers of a complete lineup of storage management software.

"We are positioning ourselves as a provider of network-based infrastructure," says ReiJane Huai, chairman and CEO of FalconStor. "We're becoming more solution focused."

FalconStor launched its flagship software, IPStor, a year and a half ago when the industry was abuzz with the promise of such cutting-edge virtualization software. The Melville, N.Y., company was founded in February 2000 by three former executives of Cheyenne Software, a backup software company bought four years earlier by Computer Associates International (NYSE: CA).

IPStor, which works with both NAS and SANs, virtualizes storage management on the local area network (LAN), thus avoiding drawing on the resources of each server to manage storage. The software lets customers use whatever hardware devices fit their needs and budgets: It's compatible with SCSI, Fibre Channel, Ethernet, and iSCSI without requiring any additional boxes.Companies like FalconStor have claimed that virtualizing storage can dramatically cut operational expenses and increase utilization. Without virtualization software, servers and storage systems don't work with other systems, and making changes often means buying new gear.

So why hasn't virtualization become the rave of the day? Observers say it's because the vendors pitching it focused on the technology rather than on the problems the technology can solve. And that's obscured the benefits of virtualization for many customers. This is especially true since the tightening of IT budgets has all but killed any interest in cool technology for technology's sake. People simply want products that will help them cut costs.

Michael Karp, an analyst with Enterprise Management Associates Inc., claims that none of the approximately 40 virtualization companies out there -- which include DataCore Software Corp. and StoreAge Networking Technologies Ltd. -- are making money. "Virtualization is a means to an end, not an end," he says. "It's not virtualization that people want to buy; it's the solution."

Like many companies in the industry, FalconStor's stock price has dropped precipitously in the past year. The stock has lost nearly two thirds of its value, having dropped to $4.31 from a 52-week high of $12.24. In 2001, FalconStor had $5.6 million in sales and lost nearly double that amount. On the bright side, the company claims to have more than $50 million in cash and no debt, and it has forecast revenues of $20 million for 2002.

Many observers congratulate the company on its swift shift of focus to the specific services it can provide, like mirroring, replication, and disaster recovery, and away from the technology it uses to provide them."If virtualization is all [FalconStor] is known for, people should look deeper," says Dan Tanner, an analyst with Aberdeen Group Inc. "They should be known for the way they leverage their virtualization capability with strong software tools."

FalconStor's latest software, IPStor 3, is more user-friendly than earlier versions of the software, analysts say. The new software allows customers to deploy these storage services for existing disks and data, whereas previous versions required them to convert their data to FalconStor's virtualization architecture first (see FalconStor Broadens Appeal).

"They really haven't changed their strategy at all, but they're looking to put a different spin on their services," says Nancy Marrone, an analyst at The Enterprise Storage Group Inc. "Virtualization hasn't taken off, but the services that virtualization provides have."

While analysts say a shift of focus is definitely a step in the right direction for FalconStor, other factors will also determine whether it will be one of the so-called virtualization companies to pull through. Some observers question whether it will be able to match the performance of hardware-based solutions in the long run. Purpose-built high-speed boxes -- like Pirus Networks's switch and those being developed by Maranti Networks, MaXXan Systems Inc., and Rhapsody Networks -- not only have a performance advantage; they're also simpler to install, since they're preconfigured, according to analysts.

"I'm not aware that [selling a software-based product] has been a huge detriment to their success," Marrone says. "But FalconStor will probably need to move towards hardware-based applications."Another thing: Size really does matter. With 120 employees spread across five continents, tiny may no longer be the right word to characterize FalconStor. Still, next to industry giants like EMC Corp. (NYSE: EMC) and Veritas Software Corp. (Nasdaq: VRTS), which have started moving into the virtualization market as well, the company is definitely dwarfed.

"For a decade now, we've been paying lip service to how important storage is," says Enterprise Management's Karp. "And now they're saying that you should trust the most important part of your company to a small company that might not be around in one or two years." [Ed. note: Karp is referring to storage startups in general, not specifically to FalconStor.]

Huai, however, is not breaking a sweat. "All markets have many competitors," he says, insisting that the number of companies offering virtualization only validates the space that FalconStor has chosen for itself. "The fact that Veritas, EMC, and others are competing in this space shows the importance of what we're doing."

The company claims to already have about 300 customers spread across five continents, at least 10 OEM relationships, and numerous other partnerships (see FalconStor Flaps Wings for OEMs). Last week, FalconStor announced its latest reseller partnership, with Dell Computer Corp. (Nasdaq: DELL) (see Dell Resells FalconStor