Why Both EMC & NetApp Want Data Domain

datadomain_logoEMC Corp. (s EMC) announced yesterday its desire to buy Data Domain (s ddup), a data backup company, for $30 a share, or roughly $1.8 billion in cash. That’s a 20 percent premium over a $1.5 billion cash-and-stock offer from NetApp (s ntap), EMC’s bitter rival, unveiled two weeks earlier. Not bad for a company whose shares were trading at around $17 a share a mere month ago.

datadomainstockThe question on everyone’s mind is, what makes Data Domain so hot? As Gary Orenstein pointed out last week, the Santa Clara, Calif.-based company is a leader in the storage category know as de-duplication, a process by which only new files are stored at each backup and duplicates are removed upon each back-up. De-duplication allows for faster backups by cutting down the amount of information processed, transferred and stored. As Gary explained:

By “de-duplicating” corporate data, particularly those terabytes destined for backup, Data Domain provided compression ratios that made its disk-based product a compelling choice over tape. It also made the integration model simple: Connect to your backup server where you used to have your tape library. Boom. Value delivered.

That NetApp, which has developed its own de-duplication technology, wants Data Domain is a good indicator of just how far ahead of the game Data Domain is. Indeed, Data Domain has done three things right:

  1. It correctly bet on the rise of multicore processors, which make the arduous task of de-duplication a breeze.
  2. It correctly bet that one could use drive-based storage media instead of tapes for backup purposes. Data Domain’s Domain’s belief is that since you’re backing up data sequentially and not actively reading those drives, they perform relatively well compared to, say, a drive containing a database that’s under a heavy transactional load. (A detailed explanation of how DD works can be found here.)
  3. Most importantly, it built a de-duplication business model that is no different from selling tape-based systems (except for lower prices). It’s a model that both EMC and NetApp can plug into their existing operations.

As Storage Mojo’s Robin Harris notes, maybe it’s time for a third bidder to emerge:

DD makes a good backup appliance with some advanced features in deduplicated data protection, something that isn’t easy. They’ve got a nifty growth rate, but $2B cash in a de-leveraging economy seems rich. On the other hand this is a company that Dell could put to very good use. Willing to make that $2.5B Michael?

In his post about the NetApp bid for Data Domain, Gary wrote that:

…with this deal, the battle for storage leadership is heating up once again. Not only does it give NetApp access to a winning product line in a growth area of the storage market, but it signals the company might be taking a new approach to its acquisition strategy, one that could make them more competitive with EMC.

The aggressive $1.5 billion offer by NetApp was a sign that the company, after long playing second fiddle to EMC, was ready to start buying as a way to regain its storage mojo.

NetApp has been losing both mind and market share to the more aggressive EMC, which has partnered with Cisco (s csco). With Oracle (s orcl) having acquired Sun (s java) (and with it, Sun’s storage business) and HP (s hpq) expected to start building its own storage systems, there are few takers for NetApp. As a result, the company’s only option was to start buying up smaller but fast-growing players such as Data Domain.

For the longest time the knock on NetApp was that it wasn’t able to buy and digest companies, as best evidenced by its struggles with its Decru and Spinnaker acquisitions. Now it’s being straight-up outbid by EMC, which is offering cash. EMC, sensing blood, wants to run NetApp out of town.

These are tough times for NetApp. In a report earlier this year, Collin Stewart analyst Ashok Kumar wrote:

Over the years NetApp has followed a product strategy that integrates most of the company’s diverse technology into its flagship Filer product line. This helps the company optimize the potential of every Filer customer they have, but it exposes them to the risk that their product platform could fall out of favor and that the company wouldn’t have other products to sell. If recent history is any indication, NetApp Filers are being phased out as strategic products in enterprise accounts. It’s possible that NetApp is simply an economic indicator for the recession’s impact on enterprise storage, but it seems somewhat likely that NetApp’s product weaknesses have been exposed by the recession and that the company will continue to have problems executing.

So what does NetApp do next? Maybe try and make a bid to buy Compellent Technologies (s cml) or 3PAR (s par), two companies with fresh approaches to Storage Area Networking. They seem to be gaining traction in the current recessionary economy. The big question then becomes, who would sell to NetApp, which is said to be losing influence in the storage market.