The outlook for enterprise IT in 2012 is still uncertain, but one thing that does seem more certain is that the demand for enterprise data storage capacity is only going to increase. While data gets more crowded, NetApp (Nasdaq:NTAP) has established itself as a strong and solid No. 2 player in this growth market and investors can still count this as a name worthy of consideration.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Third Quarter Broadly In Line
NetApp's financial results for its fiscal third quarter were broadly in line with analyst expectations. Revenue rose 21% as reported, with sequential growth of 4% and year-over-year organic growth of 5%. While the United States public sector revenue was down 7%, U.S. enterprise was up 30%.

Analysts were expecting worse margins and NetApp delivered exactly that. Gross margin fell more than two points sequentially and more than seven points annually, while operating income fell 29%. NetApp is seeing some impact from hard drive disruptions tied to the Thai flooding, but also lower margins in the pursuit of high-end customers. (To know more about income statements, read Understanding The Income Statement.)

New Products Doing Well
Although I wish the company would provide a bit more segment-level data, the information on management's conference call is enough to suggest that the company's attempts to penetrate the high-end market are going pretty well. As background, the high-end market is new territory for NetApp, as it has long been dominated by EMC (NSYE:EMC) with competition from IBM (NYSE:IBM) and Hewlett-Packard (NYSE:HPQ).

Unit sales of the company's 6000 product (the high-end product) were up 250% from last year, while sales of the mid-range 3000 were up about 22%. NetApp also launched some refreshed 2000 products in the past quarter, the first such update in some time.

Looking to Create a Two-Horse Race?
NetApp is hardly surrendering anything to EMC, and NetApp is quite competitive when it comes to price and product line-up. That said, it's probably more constructive to think of the storage market as less about EMC-versus-NetApp and more about EMC/NetApp versus everybody else.

In particular, IBM, HP, Dell (Nasdaq:DELL), and Hitachi (NYSE:HIT) have much to prove with respect to staying in the game with more advanced products. HP's 3Par acquisition should give it a longer lease on relevance, but it would seem that IBM and Dell need to get moving or risk getting left behind.

Certainly, NetApp has made several sound strategic decisions. Entering the high-end margin is likely going to cost some margin in the short term, but there's a lot of long-term promise there. Likewise, partnering arrangements with Accenture (NYSE:ACN) and Cisco (Nasdaq:CSCO) seem like logical moves. All that really remains is for NetApp to strengthen its software offerings.

The Bottom Line
I have always been a fan of EMC, but there's a lot to like about NetApp as well. While there is some risk to this company from the growth of flash storage alternatives (from the likes of Fusion-IO (NYSE:FIO), that is presently more of a niche or specialty market.

NetApp admittedly doesn't look so impressive from a P/E or enterprise multiple perspective, but a cash flow analysis offers up a picture of potentially significant undervaluation. If NetApp can maintain solid single-digit compound free cash flow growth, these shares are worth owning from a value perspective. That said, investors considering this stock should be wary of the company's No. 2 status - in the momentum-driven world of tech investing, value alone seldom leads to a winning investment. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Starbucks: Profiting One Cup at a Time (SBUX)

    Starbucks is everywhere. But is it a worthwhile business? Ask the shareholders who've made it one of the world's most successful companies.
  2. Stock Analysis

    How Medtronic Makes Money (MDT)

    Here's the story of an American medical device firm that covers almost every segment in medicine and recently moved to Ireland to pay less in taxes.
  3. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  4. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  5. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  6. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  7. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  8. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  9. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  10. Investing News

    The UAE: An Emerging Economy for Investors

    The learning from UAE on how it succeeded with timely diversification when the BRICS nations and the neighboring oil-rich economies faced challenges.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center