The Day Ahead: Despite EMC flap, StorageNetworks' IPO set to soar

Larry Dignan
4 min read

StorageNetworks (Nasdaq: STOR) is sitting on one whopper of an initial public offering. The company is making its Wall Street debut in a hit-or-miss IPO market, and is priced above range even though it has irked EMC, a key supplier and customer.

StorageNetworks, which rents computer storage, disclosed the EMC (NYSE: EMC) flap in regulatory filings earlier this week. The company said it received a letter from EMC June 21 alleging that StorageNetworks misappropriated EMC's confidential information, violated an agreement not to hire EMC employees and misrepresented that EMC is an investor.

The allegations are tough, but EMC hasn't filed a lawsuit yet. StorageNetworks, however, noted a lawsuit could be coming. The company said the EMC complaints are without merit.

That EMC flap would have been enough to derail weaker IPOs, but StorageNetworks upped its price range and then priced its 9 million shares above range for trading Friday. StorageNetworks priced its shares at $27, above its raised $23 to $25 range. The company bumped up its range from $15 to $17. Goldman Sachs is the lead underwriter.

An EMC spokesman said the company had "issues with a number of business practices." He wouldn't speculate on the possibility of a lawsuit. Given StorageNetworks' close ties to EMC -- the StorageNetworks CEO and two directors are EMC alumni -- investors may have discounted EMC concerns.

Simply put, StorageNetworks is one of those no-brainer IPOs that will make headlines with nice gains. Of course, few of you will be allowed to buy StorageNetworks at its IPO price. So you'll have to do some homework.

The buzz

The buzz about StorageNetworks revolves around its upcoming fiber optic network that will allow companies to store a ``virtually unlimited'' amount of data on the Web, the company said. The company's global network is a combination of metropolitan storage networks and long-distance fiber networks.

StorageNetworks boasts that it is the "first company to focus solely on providing data storage as a service."

StorageNetworks' strategy is clear. Storage is necessary, but many corporations don't want to build their own data centers. StorageNetworks cashes in on the outsourcing movement and allows customers to "plug in" to the network for their data.

The company could also have a predictable revenue stream. Managed storage contracts typically last three to four years, giving StorageNetworks some visibility for the future. By 2001, the company estimates 66 percent of its revenue will derive from storage contracts. The remainder of sales will come from professional services. Currently, professional services, counsel on implementing non-StorageNetworks data storage systems, account for the bulk of revenue.

But the storage services growth could be impressive. As StorageNetworks' customers need more storage, they'll have to pay more. Factor in big backers such as Dell Computer (Nasdaq: DELL), and StorageNetworks could be a long-term hit.

The risks

Although it's one thing to buy into the buzz around outsourced storage services, it's quite another to look at the financials.

For the three months ending March 31, StorageNetworks reported sales of $4.6 million and a loss of $27 million. For 1999, the company lost $24 million on sales of $6.25 million. The accumulated deficit is $51.5 million.

You should also ponder the source of sales. In 1999, 40 percent of StorageNetworks' sales derived from services provided under a subcontractor pact with EMC. If StorageNetworks doesn't smooth things over with EMC, the company will be hurt.

Meanwhile, EMC provides storage hardware and software to StorageNetworks. The company said it started buying equipment from other vendors, including Sun Microsystems (Nasdaq: SUNW) and Compaq (NYSE: CPQ).

In addition, StorageNetworks' sales depend on professional services. In the first quarter, StorageNetworks derived 72 percent of sales from counseling others on how to implement other companies' storage systems.

If companies decide not to outsource data services, StorageNetworks doesn't look like such a phenom. Some analysts don't think StorageNetworks will convince customers to outsource their vital data. A Forrester Research poll found half of large company information technology managers wouldn't outsource data services because of the risk. That attitude is something to consider. StorageNetworks also disclosed many of its data service customers are dot-coms.

And then there's the competition. StorageNetworks cited 50 companies (EDS, Intel, Qwest, Sun, Hewlett-Packard and Veritas Software to name a few) that it may indirectly or directly compete against. EMC knows it's a crowded market -- its spokesman said it had no intention of entering the managed data services market. EMC wants to provide the equipment as StorageNetworks and its rivals duke it out. StorageNetworks said it competes directly against five companies it declined to name.

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