Sunday, July 15, 2007

Tales of Storage IPOs: Hardware or Software and Components

Recently, an interesting question about the preferred packaging of the storage product by startups came up during my conversation with few private equity acquaintances. The opinions were kind of biased and fell along their past professional background.

The opinion from finance-focused guy was that most software products require less initial investment in infrastructure and working capital needs for distribution, service and support. The software startups tend to become cash flow positive and profitable lot more quickly with early market successes. The opinion from sales-focused guy was to have a product in physical form that a potential customer can visualize, feel and touch. A physical product tend to raise fewer investigative queries about the inner-workings and the inquisitive knob-turnings that tend to happen with software product.

I am of the opinion that irrespective of the storage product packaging, the differentiation tend to come, most times, from the software running under the covers or as a standalone product. One lesson, I learned from my last entrepreneurial storage adventure was that during early round of financing, the pressure for a "working" prototype is lot greater with a storage software product than hardware product.

I decided to further look in to the question of whether startups with physical storage product are perceived better by looking at the value placed on them in the marketplace. Unfortunately, the earliest available public financial data for startup is when it files for IPO registration.

This is an attempt in finding patterns for startups from the public financial data of recent IPOs by Isilon, Data Domain, Riverbed, Mallanox, Commvault and Double-Take. A visual representation of revenue, income/loss, market capitalization and change in market cap after 12 days of trading for these six recent IPOs is shown below.

Be mindful of the limitations and assumptions made to simplify the analysis such as few data points, number of outstanding shares remaining unchanged at IPO, market cap as indicator of value of company and equating price change with change in market cap over short period of trading after IPO, and adjusting revenue and income to make them consistent across all IPOs.

Some of my observations from this analysis are:

Storage software and component vendors were valued less at IPO compared to storage hardware despite being profitable and revenues at par or higher. During early trading, public markets didn't reward software and component vendors for better financial strength either. The gains in market cap during first 12 days of trading were significantly higher for hardware IPOs. Being profitable doesn't necessarily gets rewarded. The extent of profit/loss had little bearing on performance of storage IPOs. Maturity of business results in lower rewards. Double-Take was seriously undervalued and under-appreciated in all aspects.

Last Friday, Gary also wrote about the price performance of storage IPOs during past six months in his post IPO Class of 2006. He mentioned that Riverbed and Double-Take had highest percentage price gain, while Isilon is swooning and Commvault is in doldrums. May be the efficiency of the marketplace is being finally realized.

As I was using IPO data as a proxy to startup value, I decided not to extend the time period of analysis (may do anyway, now). The primary reason was to simplify the analysis and keep the data mining and normalization workload manageable - several vendors had secondary offerings, number of outstanding shares may have changed, temporary changes in financial data resulting from IPO event and proceeds, and lock-up expiration.

Share your thoughts and opinions on the success/failure of startups and storage IPOs.


  1. Anil,

    Correlation does not imply causation. The market is going to reward companies which have high growth potential with high barriers to entry. If you look closely, you will notice that Commvault's revenue growth is slower than the other fast rising companies. And that reflects in its stock price.

  2. You must be psychic. My non-storage reading for past month has been works of Edward Tufte. I finished reading two of his books and now I am on the third.

    The blog post is only my observations based on very small dataset and hopefully to be further expanded with upcoming IPOs. Sharing my observations, whether right or wrong,with others that hopefully leads to new learning for me is the goal of my blogging.

    "Correlation does not imply causation" doesn't mean "correlation does not hint causation." Also, it doesn't prevent you from performing this exercise. Sometime a real cause is only found after a series of flawed correlations link to various causes.

    Can you quantify "high growth potential" and "high barriers to entry"? Can you correlate them quantitatively to show as cause for reward?

    As companies become established and base revenue grows, their revenue growth rate tend to decline.

  3. The real question is what do you think of the products of these companies you have analyzed? You seem to work in the industry so I would appreciate some insight.

  4. Eric,

    The way you phrased your question, I assume that you visited this post through Google Finance page ... this post seems to be showing up on Google Finance page with the companies mentioned.

    Just as an overview, I am biased toward startups/emerging companies and love them all...Just from the fact that they bring to the market technology/product today which without them may not show up for 3- 10 years by established companies. Product wise, all new products and technologies have kinks. Once you look beyond this fact, they all offer great upside potential.

    I haven't really kept up with the market segment and products of Mellanox and Riverbed, so can't speak for their potential ... may be someday I will try to focus on them. Here is a quick and rough version of my thoughts on others. I may decide to write an expanded version as a blog post later on. Ofcourse, as recent IPOs you need to consider temporary bumps due to heightened media awareness, lock-up expiration and impact of income outside core operations on financial performance and spending spree with IPO proceeds.

    Isilon - Before IPO, I loved this company. At this point, I am concerned because I feel that they didn't had chance to establish themselves even as a baby Gorilla before competitors converged on their digital media segment. They still seem to be playing from underdog position in most deals. Isilon will be a big beneficiary if 800 lb gorilla NetApp loses focus from the impending perfect storm in file services market (assuming economy stays same or gets better). But every person who was involved in early phase of Isilon is worth a pot of gold. The founder's comment at NWEN (covered on the blog previously) on focusing on establishing processes and procedures going forward were start of my doubts. I hold opinion that processes aka bureaucracy typically come in the way of innovation. Can Isilon continue to do outside-the-box thinking they had at the start?

    Data Domain - I have never seen/heard a storage startup executing so perfectly like these guys (okay may be Brocade in their early years), credit goes to their leaders. Just about the time they were introducing first version of product, I heard someone say that there is a perfect storm brewing (that's how I picked up this phrase) in backup market. These guys were in the middle of it! What Isilon couldn't do, Data Domain did, they became 300 lb gorilla even before the IPO. They have great future ahead as long as they don't lose focus, don't get mired with pervasive bureaucracy of established companies, continue innovating and executing the way they have been.

    Double-Take - They are just undervalued for the right reasons. I have no appreciation for a leader that instead of focusing on strategic direction and improving the value of the company, wants to play guitar and want to be in limelight ... think Hurd not Fiorina, that is my 2 cents. Also, selling their technology in software form keeping them down. IMO, they need to productize their products in "physical" form to be appreciated more.

    Commvault - This company is behaving more like a established companies in their segment and I don't see why they should be treated better than others. Unless they break-out and introduce something beyond incremental improvements, I think they are stuck in doldrums.

    And, to stress my disclaimers, this is 100% my personal opinion and doesn't reflect opinions of anyone/anything remotely connected to me, even my friends and foes.