NTAP – Network Appliance Inc: Caching Growth over Earnings

04/07/2007

Revenue growth for the first three quarters of FY2007 (FY ending April) is very impressive, 38.6%, 35% and 35.7% respectively. We estimate that FY2007 will turn in a 35% gain in revenue; EPS to show a more modest increase to $0.72. We estimate revenue growth for FY2008 at 24% as over 50% of revenue is generated from the slowing U.S. economy.

Outstanding share count increased from 380.4M in 2005 to 388.4M in 2006. In Q3 FY2007, NTAP rectified the situation by repurchasing 6.2M shares. NTAP announced that it intends to continue its repurchase program in Q4 FY2007. Our understanding is that current share repurchases are financed by increasing long term debt. This kind of window dressing is not beneficial to long term fundamentals. With debt at 2% and a strong balance sheet there is no immediate consequence.

At least 25% of the YOY Q4 FY2007 EPS increment stems from the repurchase program. Even with the buy-back, EPS is likely to increase only 6% on a 35% gain in revenue. Margins are slipping. Until there is tangible evidence to the contrary we will have to respectfully disagree with our colleagues regarding lofty predictions for FY2008 earnings. Estimated FY2008 EPS is $0.87.

We anticipate that NTAP will continue to concentrate on revenue growth and market share for FY2008 and FY2009. We guesstimate that upon attaining $3.2 – $3.5B revenue, the focus will shift to earnings. Upon occurrence, revenue and earnings will flip meaning; revenue growth at 7% – 9% and earnings growth at 30% – 35%. Once a better economy-of-scale is obtained, it will be easier to increase margins. Until then a ttm P/E of 45 to 60 should remain the norm for this stock.

Disclosure: No conflicts, FY2008 estimates are non consensus.

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