There are three basic types of cloud: Public, where data is hosted on an outside provider's infrastructure, such as Microsoft, Amazon, or Google. This is the least expensive and most flexible. There is also a private cloud, which is more expensive and complicated to maintain, but often essential for large groups with important security and data control issues. In addition, we have hybrid, which is a mix of public and private clouds, the former for less strategic functions, the latter for those requiring more control and customization.

NetApp specializes in this last formula and offers its customers turnkey packages designed above all to be flexible and economical. It is clearly doing this with some success, since its solutions are used by all the leaders in all industries. In a classic "gold rush" scheme - in this case the transition of IT infrastructures to the cloud - we have here a classic case of a player who sells shovels and picks instead of digging mines.

The outlook for the cloud remains bright indeed, with demand growth estimates for public cloud services of 15% per year and 25% per year for private cloud services.

That being said, beyond the appearances and promises, NetApp's financial analysis reveals a different profile than the meteoric growth companies often see in the technology sector. In fact, NetApp is a company that has completely reinvented itself, from a hardware vendor to a software solutions provider and strategy consultant. This pivot has allowed it to maintain its revenues and cash flow, but not so much to grow its business. In fact, NetApp is above all a feat of financial engineering and good management. As such, it is a situation that will be of interest to sophisticated investors who are well aware of these dynamics.

Impressive results

Over the last decade, annual revenues have remained remarkably constant, at $6bn on average. On the other hand, the margin profile is improving significantly – which is natural in a hardware vs. software transition - while costs remain remarkably under control.

The financial position is excellent, with $5bn of adjusted liabilities. However, to be precise, there are $4bn of deferred revenues, counted as a liability according to accounting conventions. It is an asset that could be assimilated to an "order sold but not yet delivered in full", covered by current assets alone (including $4bn of cash).

In terms of cash flows, and this is where it is interesting, and where the financial dynamics are well understood, the group has generated in aggregate over the last decade $9bn of cash profits (restated for stock options), or free cash flows (FCF). 

Cash management is not a problem in businesses of this nature: the activity is not very capital-intensive, the cost structure is essentially variable, and customers pay in advance: external financing needs are therefore nil.

In terms of capital allocation, NetApp bought back $9.5bn of its own stock (net of stock options), paid out $2.5bn in dividends, and spent $2bn on acquisitions - the purpose of which was not to grow revenue but to maintain it. The $5bn "gap" between the use of these resources totaling $14bn and the sum of the cash profits of $9bn was financed from the plethora of cash - to the tune of $3bn -and by a slight increase in debt of roughly $1bn.

All in all, NetApp is a mature business that has been able to reinvent itself to maintain its volume of activity and its profitability, but it is not in itself a growing business. So, this is a typical example of a mature business that returns capital to its shareholders, as opposed to a growing business that solicits more capital from its shareholders.

An investment that comes with many risks

The company's clever financial engineering will have significantly boosted the profit per share, because if the FCF remains more or less comparable year after year, the number of shares in circulation has been divided by a third over the period. Thus in 2013-2017, the average FCF per share is $2.3, while over the period 2018-2022 it is $4.4! And this, despite the fact that in fiscal years 2019 and 2020, the working capital requirement has consumed resources, whereas the company usually has a negative WCR.

At a price of $68 per share, we are on a typical multiple of x15 the average cash profit per share of the last 5 years, which is extremely typical multiple of a mature, profitable and well managed business in this rate context.

This is because x15 earnings means earnings yield of 6.6%. With a risk-free rate (10-year US Treasury bonds) at 3.5%, this translates into a risk premium of 3%: This is the typical value of equities without leverage.

However, there are many risks associated with this stock: rising interest rates continue to compress the multiple, NetApp's hyper-competitive industry, falling margins due to price wars, and prolonged inability to return to revenue growth. Indeed, while revenue has been constant over the last decade, with inflation, it is actually falling. And let's remember that several executives sold their shares at prices close to what they are now… So, for now, it might be best to steer clear, especially in this context, which brings many better opportunities!