Analysis: EMC doesn't need Data Domain, but damages chief rival NetApp

In an industry where bidding wars come around about as often as leap years, the battle between storage rivals NetApp Inc. and EMC Corp. over Data Domain Inc. is indeed a very unusual phenomenon. Even more so because -- unlike most major league baseball stars -- Data Domain isn't likely to choose the winning bidder based on money alone.

Many industry observers believe EMC isn't all that interested in Data Domain and instead began a bidding battle to force its nemesis NetApp to raise its offer for the de-duplication vendor. If they are right, the plan has worked brilliantly -- NetApp was forced to boost its initial offer by $400 million after EMC upped the ante with its $1.8 billion bid early this week. But that's a lot of cash to be swinging around for spite's sake.

"My first take was 'oh, that is really smart,'" said former EMC employee Steve Duplessie, founder and senior analyst at the Enterprise Strategy Group in Milford, Mass. "And, even if NetApp wins, they'll probably have to accept the all-cash variant. For NetApp, this is 'Texas Hold 'Em.' But EMC is big enough where they could screw it up, and it would be bad, but they'd survive."

In fact, EMC does not need Data Domain. EMC already sells re-branded data de-duplication technology targeted at the Data Domain's backup process market. And it has the resources to buy any of several smaller, less expensive and mature de-duplication vendors, such as FalconStor, Sepaton or Permabit. It could even buy the much larger Quantum Corp. for its de-duplication technology and then sell off what it doesn't want, much like it did after buying Data General Corp.

"Everybody's got de-dupe. Everybody. I think I have a de-dupe technology," Duplessie joked. "So there's obviously both emotion and bravado involved at this point. But it also has to be 'I'm scared of the other guy having it' as much as it is 'I want it.' "

Nonetheless, if EMC does buy Data Domain, the acquired products wouldn't go to waste. Duplessie pointed out that many are ideal to be sold through the midrange sales channel via EMC partner Dell Inc. Currently, only EMC's Clariion product line moves through that massive Dell channel, which accounts for more than a tenth of EMC's revenue, even though it is waning a bit. So EMC could leverage its partnership with Dell in a new and dynamic way.

An EMC acquisition would probably force the company to discontinue reseller partnerships with FalconStor and Quantum, through which it offers two virtual tape libraries and an archive disk array, even though EMC CEO Joe Tucci said last week the agreements would remain in place. You don't spend $2 billion on an acquisition and continue to sell duplicate technology -- if nothing else de-duplication teaches you that.

There's no doubt Data Domain wants a marriage to any sugar daddy to be a healthy one where its talented employees are retained and there's a strong expansion of the marketing and development of its products. Clearly, both NetApp and EMC offer that, so choosing between the two must go beyond the pocketbook.

So far at least, the battle for Santa Clara, Calif.-based Data Domain hasn't exactly hurt its stock price, which has just about doubled to $33 a share, since NetApp's initial offer last month. In June alone, the stock has risen by 24%.

When NetApp started the de-dupe duke out, many observers thought its eye-popping $1.5 billion cash and stock offer wouldn't be topped. But less than two weeks later, Hopkinton, Mass.-based storage giant EMC showed up like an unwelcome relative at the party with $1.8 billion in cash -- 20% more than the NetApp proposal. On Wednesday, an insecure NetApp fired back with a $1.9 billion cash and stock bid, and Data Domain quickly accepted it. But based on the history of the process-- Data Domain also put its John Hancock on the earlier NetApp proposal -- it still may not be over. EMC could still come in with a hostile takeover bid and woo Data Domain stockholders over to its side.

Both firms are sweet-talking the stockholders, executives and employees of Data Domain, one indication that EMC may be more serious than the experts believe.

During a late Monday afternoon press conference, EMC CEO Joe Tucci promised that his company would run Data Domain as a product division within EMC, and would increase its R&D investment in Data Domain technology. "We look forward to giving the Data Domain employees a warm and heartfelt welcome into the EMC family. I would like to remind everyone EMC has a good track record of integrating companies, retaining and growing key talent and achieving results," Tucci said. The CEO didn't mention the less-than-stellar integration of VMware Inc. technology into EMC, though to be fair, that acquisition has been a financial success so far.

On the other hand, NetApp does not have a good track record with at least some of its acquisitions, notably the Spinnaker Corp. deal in 2003 and the acquisition of Decru Inc. in 2006. Both companies went through a very rocky integration road with NetApp. "I do happen to believe that NetApp does acquisitions miserably," said Arun Taneja, founder and president of the research firm, Taneja Group Inc.

Despite questioning the motives of EMC, many industry observers agree that that company would offer Data Domain a better corporate culture while offering strong sales channels.

On the NetApp side, Data Domain likely wouldn't try to integrate the data Domain products with its own to avoid the problems of past acquisitions. This acquisition could be more successful than past ones because NetApp is expected to better leverage its massive sales and marketing channels to promote the products.

NetApp does face the strong challenge of getting a return on its enormous bid for the de-duplication vendor. To put the deal in perspective, Data Domain's 2008 revenues totaled $274 million, roughly one-seventh the amount of NetApp's latest offer (Data Domain's market capitalization is around $1.99 billion). NetApp's 2008 sales were about $3.3 billion last year, so it's offering more than half its annual revenue for de-duplication technology. By contrast, EMC's 2008 revenue came in at about $14.8 billion.

"It's really hard to justify the numbers for either [NetApp or EMC]," Duplessie said. "That number [Data Domain's revenue] is going to have to go from $300 million to $2 billion to pay for itself. And that's not going to be easy. I don't think there's a long window here. This isn't like EMC buying VMware, where there are no competitors and the market is clamoring for a solution."

The bidding war between EMC and NetApp could come down to which corporate culture will best matches that of Data Domain. Right now it appears that Data Domain, which has refused to comment about the battle between storage rivals, loves NetApp.

And indeed, few believe at this point, particularly after EMC yesterday reaffirmed its initial $30-per-share bid for Data Domain, will come back with another bid. Even if they don't, the damage has been done -- as they say in baseball -- and EMC is already the clear strategic winner.

Copyright © 2009 IDG Communications, Inc.

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