One Way Out

If the storage IPO is not dead, its certainly comatose.

Successful storage startups used to grow up into big strong public companies. Now they merely become pieces of bigger public companies.

It seems hardly a week goes by – and certainly not a month – without a public company gobbling a private storage firm. Yet only one storage company, Xyratex Ltd. (Nasdaq: XRTX), has gone public over the past 30 months (see Xyratex Swims in Public Pool).

These aren’t exactly boom times for IPOs in any industry. Still, companies are going public in some sectors. According to Hoover’s, 41 companies completed IPOs in the first quarter of this year and 35 more this quarter. When it comes to public and private storage companies, though, there's a preference for the mating dance of acquisition. The large public companies derive a good deal of their technology that way, and startups give their investors a nice payout.

A year ago, it looked as if the IPO drought was coming to an end. When Xyratex went public on June 24, 2004, Engenio Information Technologies Inc. had already filed paperwork for an IPO. Wall Street buzz said CommVault Systems Inc. was close to going, and Softek Storage Solutions Inc.’s spinoff from Fujitsu was considered a precursor to an IPO (see Window of Opportunity and Softek Taken in Management Buyout). Executives at companies such as BlueArc Corp. and Xiotech Corp. said they were watching to time their own IPO moves.They watched and did nothing. Engenio backed out after pricing shares, and nobody else has come close (see Engenio Gets Cold Feet).

These days, the best exit strategy is an acquisition, and who can blame startups? Since 2003, we've seen purchase prices such as EMC Corp.’s (NYSE: EMC) $1.7 billion for Documentum and $1.3 billion for Legato, and Veritas Software Corp.’s (Nasdaq: VRTS) $609 million for Precise. In the last two months, Network Appliance Inc. (Nasdaq: NTAP) bought Decru for $272 million, and Cisco Systems Inc. (Nasdaq: CSCO) got Topspin for $250 million.

These rich payouts don’t necessarily bode well for the industry, though. When companies go public, they bring new money into the sector and create a buzz about the technology. That makes it easier to attract investors for other storage companies. Industries get stale when companies fail to hit the secondary markets.

Startups certainly like giving investors and potential customers the impression they want to go public rather than get acquired. It's the "year or so" syndrome: Execs talk about becoming cash positive and exploring the public markets "in a year or so." In a year or so, those startups (if they're still around) say the same thing. And so forth. No one expresses hopes of doing well enough to get bought up. Until they get an offer.

Is there an end in sight to the IPO drought? Few storage startups will say much about going public this year. There certainly are some good candidates. Software startups AppIQ Inc., CommVault, and Softek; systems vendors Engenio, EqualLogic Inc., Isilon Systems, LeftHand Networks Inc., and Xiotech; consultant GlassHouse Technologies Inc.; and service provider Arsenal Digital Solutions Worldwide Inc. have shown they can stand on their own. Some of them are likely profitable, waiting only for the market to improve before trying to go public.But don’t count on it. Perhaps EMC or another systems vendor will grab Softek to shore up its SRM package, or one of the struggling tape vendors will consider CommVault a good fit both technology- and revenue-wise and make an offer the startup can’t refuse. If recent history tells us anything, it is that the latter scenario has a lot better chance of happening than an IPO.

The odds are much better that acquisitions will continue. While market leaders such as email archiver KVS and security appliance Decru have been among the acquisitions over the last year, targets are more often companies with desirable technologies that have yet to make a financial splash.

And there are plenty of them out there ripe for the taking. Continuous data protection (CDP) vendors such as Mendocino Software and Revivio Inc.; NAS virtualization startups Acopia Networks Inc., NuView Inc., ONStor Inc., and Rainfinity; and WAFS startups such as Riverbed Technology Inc. and Tacit Networks Inc. are well positioned players in hot technologies. Brocade already has a financial stake in Tacit, so don’t be surprised if it swallows the entire company if its OEM deal works out well.

In any case, you can expect to see more startups become pieces of big companies than stand alone on their own. The exit path for startups these days is a one-way street.

— Dave Raffo, Senior Editor, Byte and Switch0