StorageTek Rides High

In times of crisis and uncertainty, dependable legacy technology is king. While the stocks of many cutting-edge storage networking infrastructure companies are struggling near 52-week lows, 32-year-old StorageTek (NYSE: STK), whose focus is still tape drives, is riding high.

StorageTek reported third-quarter earnings after Wednesdays market close of $18 million, or 17 cents a share, clobbering analysts’ expectations of 10 cents a share. Revenue of $498 million was slightly lower than the consensus $506 million. The company disclosed Oct. 11 that earnings would be better than the 9 cents analysts predicted at the time and that revenues would be roughly $500 million.

The results show a sharp improvement over last year’s drab results -- a period just after the company had completed a reorganization. Earnings were up 183 percent from the year-ago quarter of $6.3 million, or 6 cents per share. Revenues climbed 2 percent over last year’s $487 million and gross profit margins improved to 45 percent from 43 percent. The company’s cash reserves grew by $45 million in the quarter to $352 million.

But to achieve these strong results, StorageTek paid a price -- suffering the last two years with some of the same afflictions that now plague other industry players. The company took a hit in early 1999, when due to a components shortage it could not fulfill its demand for its flagship product. That same year, IBM Corp. (NYSE: IBM), which had previously resold StorageTek products, became a competitor. And if that weren’t enough, a federal appeals court that summer ruled that the company had to pay $71 million in a patent duplication lawsuit.

StorageTek lost $75 million that year, amidst growing speculation that the market for tape storage was dying. But the company retrenched in 2000 by spinning off unprofitable business units, implementing numerous cost-cutting measures, eliminating 1,200 jobs, and hiring new CEO Patrick Martin.Last year, StorageTek led the high-end tape-drive industry with 45 percent of the 56,000 units sold worldwide, according to Freeman Reports, a market research firm. IBM was second with 41 percent. Freeman president Bob Abraham estimates worldwide market revenue from OEMs was $1.12 billion last year.

StorageTek should continue to reap solid returns from this market. Abraham anticipates only a 4 percent compound annual growth rate in unit sales for the high-end tape-drive industry through 2006. But he expects revenues to increase 9 percent annually to $1.9 billion in 2006 because of wider deployment of newer and more expensive technologies, such as Fibre Channel.

Freeman also believes the tape-drive industry may show a short-term boost following the Sept. 11 terrorist attacks. Despite slower data access and transfer speeds, he notes tape is more easily transportable and still costs only about one-tenth as much as disk storage.

Overall, StorageTek’s year-over-year tape products sales grew 4 percent and now represent 80 percent of total product sales. In other areas, the company's service revenues rose 9 percent. But revenues for disk products were off 27 percent and networking products were off 6 percent.

And that raises a red flag: Although cost cutting put StorageTek back on track, to get to the next level the company will have to raise its top line, which may be a big challenge if it doesn’t diversify much beyond the tape business.To achieve diversification, analysts believe StorageTek will have to revive its ailing disk business, but many are skeptical the company will ever be competitive with EMC Corp. (NYSE: EMC) in that segment. They say StorageTak may be better counseled to follow another new company focus -- tape automation and virtualization using storage area networks.

StorageTek’s stock was trading at $17.00 in after market trading late Wednesday, up 2.91 percent over the day’s close of $16.52.

- Tom Davey, special to Light Reading, http://www.lightreading.com