PC maker Dell, Inc. (NASDAQ:DELL) should acquire data management software firm CommVault Systems, Inc. (NASDAQ:CVLT) sooner than later in a move that may give the company higher margin storage assets and allow it to expand into data management software market.
...it may make sense for Dell to make a near-term move than wait. We believe a Commvault takeout would be a continuation of Dell's recent strategy to replace its lower-margin OEM/reselling arrangements with higher-margin fully-owned Storage assets, ThinkEquity analyst Rajesh Ghai wrote in a note to clients.
Commvault and NetApp Inc. (NASDAQ:NTAP) announced an OEM arrangement on May 31st under which NetApp will resell an integrated SnapProtect solution which essentially packages NetApp's popular array-based replication and archiving software with Commvault's snapshot based backup/ data movement engine in Simpana 9.
The integrated solution essentially enables NetApp to sell a full backup solution - something it could not do in the past - and potentially allows it to compete more effectively against EMC and IBM in the Backup Storage market.
Ghai views Commvault's OEM deal with NetApp as a potentially significant inflection point in Commvault's growth and evolution.
The analyst believes Commvault could potentially achieve a much higher attach rate to NetApp's systems, than in its previous OEM arrangements -- Dell and Hitachi Data Systems. Dell contributed 23 percent of Commvault's fiscal 2011 revenue, which equates to $72.4 million.
According to IDC, NetApp had 2.4 percent points higher market share than Dell in the fourth quarter of 2010 in the External Disk Storage systems market.
We note NetApp's higher Storage market share and penetration of virtualized environments vis-a-vis Dell, which could potentially make NetApp a potentially larger OEM partner for Commvault over time than Dell, Ghai said.
Meanwhile, Dell has seen upside to Street margin expectations in recent quarters primarily due to higher gross margin on its Compellent and Equalogic products that have replaced the EMC-based OEM products that Dell was selling into the Storage Area Network market in the past.
Dell's stock has also reacted positively to the gross margin upside in recent quarters.
By acquiring Commvault, Dell may have an opportunity to expand in to the Data Management software market and thus reducing the resale of both Commvault, but more importantly Symantec's (NASDAQ:SYMC) NetBackup/Backup Exec solutions over time.
We estimate conservatively Dell sells about 4x of Commvault's software volume in terms of SYMC Backup Exec and NetBackup solutions. (SYMC, according to our estimates, has about 40% share vs CVLT's approximately 4%), Ghai noted.
Hence, by acquiring Commvault, Dell has the opportunity to replace its reseller margins (about 20 percent) on about $350 million of revenue with software industry margins of at least 85 percent.
In fiscal 2011, Commvault earned $21 million, or 45 cents a year, on revenue of $314.8 million.
What If Dell Delays Buying Commvault?
If Dell delays the decision to acquire Commvault, it may risk seeing Commvault's takeout price increase significantly which Ghai believes will likely occur if the NetApp OEM deal is as successful as he believes it could likely be.
While we understand that the NetApp-Commvault OEM deal may take a few years to fully ramp, we believe early evidence of the success of this deal could potentially get Commvault's stock moving on the upside, Ghai said.
A valuation that takes into account the possibility of NetApp being a 20 percent customer in a few years time, could be significantly higher than where shares are currently trading.
Assuming Commvault's current business without NetApp grows at 15 percent compound annual growth rate (CAGR) over the next 3 years and NetApp becomes a 20 percent customer at the end of 3 years, Commvault with 20 percent operating margins and a 30 percent tax rate could earn $1.68, which could imply more-than-doubling of its current earning power as evidenced in fiscal 2011.
We believe if Dell is serious about making a move on Commvault, it may be better off making it sooner than later, said Ghai who has a buy rating and $44 price target on Commvault shares.
Shares of New Jersey-based Commvault closed Friday's regular trading session at $37.28 on Nasdaq. The stock has been trading between $17.25 and $42.30 during the past 52-weeks.