By Maxim Group ($41.49, Aug. 14, 2017)

Our 12-month price target on NetApp goes to $56 from $46, and we are upgrading to Buy from Hold.

Checks indicate NetApp’s (ticker: NTAP) hybrid cloud capabilities have gained traction, a key differentiating factor aligned with long-term market direction. With continued improving organizational efficiency and reemerged product differentiation, we believe NetApp is on the path to achieving a 25% operating margin in five years, up from 17.2% in fiscal 2017. We are moving to a discounted-cash-flow-based valuation framework (from an acquisition-adjusted enterprise value (EV)/free cash flow (FCF) multiple basis), which yields a 12-month price target of $56 (35% upside). NetApp has developed a portfolio of hybrid cloud data management products that include NetApp Private Storage (released in late 2012), ONetApp Cloud (launched in late 2014), Altavault (acquired from F5 Networks (FFIV) in 2015), CloudSync and Cloud Control (both released in late 2016). These products form an effective complete hybrid cloud data management capability that spans mission critical workload bursting from a private to a public cloud (NetApp Private Storage (NPS) to the more basic disaster recovery (AltaVault) capability.

On our annual Silicon Valley bus tour, Chief Executive and President George Kurian reiterated from the Analyst Day that the company has 1,500 hybrid cloud customers (we estimate out of about 60,000 customers) that are utilizing NPS and thousands of customers that are utilizing one of NetApp’s hybrid cloud products with the customer base growing triple digits. Our limited channel checks also indicate that NetApp has begun to gain mindshare with resellers in terms of the company’s hybrid cloud capabilities, which is providing a significant differentiator for NetApp that is aligned with the longer-termed trend of hybrid cloud adoption.

We believe NetApp has room to improve the operating expenditure-to-revenue ratio by 500 basis points and overall gross margin by 700 basis points, leading us to comfortably model operating-margin expansion from 17.2% in fiscal 2017 to 25% by fiscal 2022 and compares to Analyst Day guidance (provided on April 5) for fiscal 2020 of 18% to 22%.
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