NetApp Seeks Growth With Acquisition of Data Domain

On a day it reported a decline in quarterly profit and sales, NetApp said it would try to rekindle growth by spending around $1.5 billion to buy Data Domain, a leading vendor of backup systems that use data deduplication technology to reduce storage needs.

NetApp said it will pay $25 in cash and stock for each share of Data Domain, which is a 40 percent premium to where the company's stock was before the news was announced. Bloomberg reported that Data Domain stock holders will receive $11.45 in cash and 0.75 of a NetApp share.

The move is part of an ongoing consolidation trend in the storage industry and among data center vendors. Server, networking and storage vendors companies are looking to fill in their product portfolios in order to offer a more comprehensive set of systems and gain more revenue from each customer.

NetApp may have felt it needed to do something to get back on a growth trajectory. In the quarter ending April 24, NetApp said Wednesday it had net income of $75.1 million, or 23 cents a share, compared to earnings of $89.8 million, or 26 cents a share, in the same quarter a year ago. Adjusted earnings were 31 cents per share in the latest quarter. Revenue fell to $879.6 million from $937.7 million.

Data Domain, in contrast, doubled its revenue in 2008 to $274 million and reported net income of $21.6 million, compared to a loss of $3.7 million a year earlier.

NetApp executives said they plan to build on that growth by using their extensive sales and distribution channels to offer Data Domain's products to more customers, especially in overseas markets. Executives from both companies said there is little overlap in customers, but that there are enough IT departments using products from both to demonstrate that they work well together.

"This combination is a great opportunity for both NetApp and Data Domain," Dan Warmenhoven, chairman and CEO of NetApp, said in a statement. "Data Domain is an innovative high-growth company with a complementary product line ideally suited for multi-vendor environments where customers want to minimize their use of tape for backup. NetApp has the distribution channels and international reach to offer Data Domain products to more customers, accelerating growth and market adoption."

NetApp officials downplayed any product or technology overlap and said it was too early to discuss how many Data Domain employees would move over when the acquisition is completed in 60 to 120 days. NetApp Chief Marketing Officer Jay Kidd called the product line "complimentary" and said Data Domain's products, which will become a separate product line within the company, can expand NetApp's presence in the market for heterogeneous disk-based backup. NetApp currently offers data deduplication on primary storage as well as in a virtual tape library backup product called NearStore VTL. Earlier this month NetApp said this year, 7,200 of its customers are using data deduplication on more than 37,000 systems that contain 514 petabytes in storage capacity.

The company said the Data Domain acquisition will boost its ability to compete in the disk-based backup market, which is growing fast as data deduplication helps customer reduce their overall storage needs by eliminating redundant copies of files and other information.

"The backup storage market is undergoing transformation as more customers are moving from tape to disk to backup and archive their data. There are two camps, one wants to use tape and VTLs and another -- a much faster growing segment -- that wants to minimize their use of tape. Data Domain has a leadership position in that market," said Kidd.

At the moment, Kidd said NetApp didn't plan to end or combine any product lines and will continue to work on deduplicating technology for primary storage as well as backup systems. He said the acquisition was about "incremental business opportunity" and not a move simply to buy technology. "A broader portfolio puts more tools in the bag," he said. NetApp will form an integration team to look at opportunities for merging technologies and perhaps products. "There are overlaps of the product lines at the edge and we will work out that in the integration phase. We don't intend to take any product out of the market for which there is strong customer interest," Kidd said.

Paying $1.5 billion for a company that reported net revenues of $287 million for 2008 shows the value of data deduplication in today's market, said Charles King, principal analyst at consultancy Pund-IT and a Bytre and Switch blogger. He said EMC's purchase of Avamar in November 2006 for $165 million appears "both extremely prescient and a remarkable bargain. Given the sort of premium Data Domain required, NetApp appears to be willing to pay to play a particularly energetic game of catch-up."

There may be conflict between NetApp's VTL data deduplication technology and that offered by Data Domain and "it I would be a natural happening for NetApp to move toward the Data Domain offering over time," said Tom Trainer, president of analyst firm Analytico. Rationalizing the technology means that NetApp can use its deduplication technology on primary storage and use Data Domain's on backup and archiving systems. "Data deduplication is growing in importance as users look toward greater leverage of resources, especially in these tight economic times."

Trainer agreed with other analysts who predicted more consolidation in the IT market. Noting that NetApp just reported poor earnings, "it appears that all vendors are feeling the pinch of the recession," he said. "Acquiring Data Domain may re-energize NetApp in the dedupe segment and add to revenue over time. [Consolidation] is bound to happen, even in great economic times. However, the recession will drive even further consolidation throughout 2009.

David Vellante, principle contributor to Wikibon, a community of IT professionals and research analysts, called the acquisition a good strategic move for NetApp, but said the company overpaid to buy Data Domain. "It is clear they thought their existing dedupe strategy was not going to get them to a leadership position so they went out and bought the leader. They will be able to take Data Domain's data dedupe and data reduction technology and put it across their entire portfolio to better compete with companies like IBM and EMC," he said.

The big question is how long it will take NetApp to integrate Data Domain's technology and products into its products, he said, since rivals like IBM and EMC are further along that path. The other challenge comes from data center trends. "Fewer IT managers trying to optimize on the storage part of the stack. They are integrating storage and servers and networking and software and trying to optimize across the stacks," he said. "NetApp is increasingly competing with vendors that have a much broader portfolio of products and the tight focus on storage could become a liability."

Vellante thinks the market for data center systems will shrink to a few major vendors like IBM, Hewlett Packard, Oracle, Cisco and Microsoft, and companies that focus on a single technology will play less of a role. "While the acquisition of Data Domain makes NetApp a more attractive acquisition candidate because it can now compete in more parts of the storage market, the question becomes who will buy them. That isn't clear," he said.