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DATA STORAGE STARTUPS: VCS' FAVORITES

Data, in recent times, is being created at phenomenal rates. And, all that data must be stored, managed, and protected. Consequently, venture capitalists (VCs), have begun showing much enthusiasm for bigger and better data storage systems. Recently, VCs opened their wallets to a big number of data-storage startups that are hoping to cash in on the storage explosion.

Mission Critical

According to some estimates, for every person on earth, 250 MB of data is produced each year. Another research, conducted last year by the University of California at Berkeley, says that the amount of digital information produced in the world is doubling as often as every two years.

These facts may not seem disturbing to the layman, but the issue of data storage is of critical importance to businesses. Though they may have slowed down their spending on technology, companies are still continuing to collect data. This means both big and small corporations need storage systems to handle everything from e-mail, voice and video files, for all the data generated by customer-care and supply-chain software. Some estimates indicate that corporate America's need for data storage capacity doubles every eight to 12 months.

And since data is the life-blood of a company, storing, managing and protecting it is a priority for enterprises. Forrester Research projects that storage will account for 17% of the budgeted spending on information technology (IT) in 2003, compared with 4% in 1999.

In the aftermath of the Sept.11 terrorist attacks, companies are focusing more on disaster readiness. They are therefore expected to spend even more on data storage and backup systems.

Storage Networking Marches On

The accelerating demand for data storage leads some analysts to believe that storage could continue to be one of the fastest-growing spaces in technology over the next three to five years.

To be sure, a rise in demand is generally followed by technological innovation. Storage is no longer simply about disk drives. The two most discussed storage innovations of the last couple of years are storage networking and virtualization.

Until a few years ago, storage devices were usually attached to a company's local area network (LAN) through a server. Today, many companies are deploying more complicated solutions such as storage area networks (SANs) and network attached storage (NAS). Network storage is different from the old-style storage in that users no longer rely on a multipurpose server to access data. Both SANs and NAS pool data so that it can be centrally managed and shared by all the servers.

SANs link disparate servers into a unified, shared resource, while NAS deploys a specialized "appliance" that maintains a single file system across a wide range of computers.

SANs, NAS and storage software applications are the areas that have generated the most interest in customers and investors lately. Experts think that the shift to networked storage schemes is completely unavoidable.

Market research firm International Data Corporation (IDC) believes that more than half of all disk storage systems will be purchased in either SAN or NAS configurations by 2003, and two-thirds of the market will be SAN or NAS by 2005.

According to IDC, sales of storage networking firms will expand from $8.1 billion in 2000 to $37.5 billion in 2004.

As storage networks continue to grow in size and value, companies are finding that storage virtualization tools enable them to better manage their storage resources and optimize their data. Perhaps, right now, "virtualization" is the hottest trend among storage networking companies, as most of them are also developing storage virtualization equipment. These platforms combine features of SAN and NAS devices, providing hardware and software that allow multiple storage to be managed as single entities.

The promise of virtualization is that it will significantly improve storage manageability and bring higher capacity to customers while cutting costs.

Research firm Gartner Dataquest predicts that in the next few years, storage virtualization systems will be the fastest-growing segment of the storage management software market. The firm estimates that revenue from storage virtualization products will be $307.3 million this year, growing to $1.2 billion by 2005.

Given these predictions, it's not surprising that a plethora of startups have cropped up operating along the new concepts in data storage. Furthermore, they have even managed very easily to catch the eye and money of skittish venture capitalists.

VC Money Flows

Little wonder then that this year, when venture money has all but disappeared for some technology startups, venture capitalists are lavishing money on data storage.

Venture Economics reports that about $725 million was invested in nearly 30 firms involved in the sector during the first half of this year. And, VC money is continuing to flow into storage startups in the second half of the year too.

The VC companies with the most storage startups in their portfolios are Battery Ventures, New Enterprise Associates and OneLiberty Ventures.

VCs seem to be especially attracted by those startups that are building high-performance storage systems with claims of possessing new fundamental storage architectures that are more efficient and cost less than currently available alternatives. Recently, major players in this sector closed funding rounds.

Cereva Networks Inc, a developer of Internet Storage systems, got its latest round of VC funding -- easing its path into the next-generation storage networking market. On Sept. 26, Cereva announced the closing of $51 million in new equity funding from corporate and institutional backers. This is the company's fifth round of financing -- estimated to be enough to carry it to profitability.

Set up in 1998, Cereva has taken a bold approach to the storage market - it combines standard SAN architecture with NAS file access structure, and streaming media software in a storage system that can handle data capacities of 230 terabytes to one petabyte. Cereva's product is especially designed for operators of Internet data centers, including Web content and service providers.

Marlborough, Mass.-based Cereva hopes to introduce its product -- a high-end switch-plus-storage array for use in carrier networks -- late this year, with revenue, beginning to come in the first quarter of 2002. NaviSite Inc is one of the three companies that have already begun testing Cereva's software-enhanced server and switch.

Pirus Networks, Cereva's close competitor, is also making a storage-utility switch used for data-storage networking -- but it is designed for heterogeneous networks, where it can be used to hook up storage units from different vendors.

Acton, Mass.-based Pirus has raised $58 million in capital since its inception in 1999, the latest round being closed just a day after Cereva's announcement of its fifth round of VC funding in September. Pirus' customer StorageNetworks Inc. (STOR) is doing its beta testing and the company expects to have its infrastructure device for general release before the end of this year.

3PARdata of Fremont, Calif. is developing software and hardware that can help large businesses, network vendors, and storage and information service providers, to store vast amounts of data in new ways. Its servers run on proprietary software and let customers integrate different storage devices into a single storage network.

Founded in 1999, 3PARdata raked in a hefty $100 million third round of funding in July this year from existing investors as well as Sun Microsystems Inc, Veritas Software Corp and Oracle Corp. The deal pushed the company's valuation up to a whopping $300 million, despite no announced product.

The firm expects to offer its first commercial product by the second quarter of 2002. The product will focus on ways in which companies can manage and centralize important business information, facilitating easier access and search.

Again in September, VCs invested $26 million in a third round of funding in Seattle-based YottaYotta, to help the company bring its distributed storage products to market by the second quarter of 2002.

The startup, founded in 2000, uses a different approach -- it provides storage in a distributed manner that allows for real-time disaster recovery. YottaYotta is developing highly scaleable storage solutions based on massively parallel computing technology that will operate over distributed networks.

Panasas Inc is another startup working on a next-generation distributed system that shares the processing power needed to store data among a number of smart devices. The system uses existing industry-standard hardware, and the company claims it will cost less than what is available today from industry leaders.

Fremont, Calif.-based Panasas announced Oct. 1 that it has secured $25.4 million in second-round funding.

By and large, startups are more aggressively pushing storage virtualization -- the pooling of physical storage from multiple network storage systems into what appears to be a single storage device -- which theoretically means the entire infrastructure can be managed from one location. Furthermore, VCs too have been quick to invest in them.

The latest sign of VC enthusiasm for virtualization was evident when Fort Lauderdale, Fla.-based DataCore Software Corp. announced on Oct. 30 a $31 million third round of funding, bringing its total capitalization to $72 million.

The attraction of the two-year-old storage virtualization and networking software maker was that its storage software can cut costs and increase efficiency without a major network overhaul.

DataCore has been marketing its SANsymphony software for more than a year now. The startup has entered into an agreement with Fujitsu Ltd., under which, the Japanese company will sell DataCore's software solutions with its hardware. DataCore also has a similar relationship with IBM Corp.

Apart from startups, many big names are also aiming to take advantage of the promise of the virtual storage system market. Hewlett-Packard Co, Compaq Computer Corp, EMC Corp, Hitachi Data Systems and IBM have all announced plans to deliver storage virtualization products.

The list of data-storage startups recently blessed with funding is long. Sanrise Group Inc, BlueArc Corp, Nishan Systems Inc, Zambeel Inc -- have all enjoyed vast amounts of VC money. Obviously, a great number of young companies are involved in next-generation storage, some of them still in stealth mode now. And one common factor is that they all need plenty of funding to get to and establish themselves in a market dominated by some public heavyweights.

The Leaders of the Pack

The number one spot in the data storage business has long been occupied by EMC, whose market cap currently sits at $36.18 billion. The Hopkinton, Mass.-based giant develops a wide range of storage hardware, software, and services that function together as storage area networks. EMC sells these systems to Fortune 500 clients.

IDC estimates that in networked storage, including both SAN and NAS implementations, EMC's market share will be 38.9% in 2001. This exceeds the combined market shares of the next three biggest players in the arena after EMC.

EMC will continue to have a 37.9% revenue share in the SAN market. Major players in the market after EMC are IBM, Compaq and Hitachi Data Systems. IBM's market share may nearly double to 18.2% in 2001, overtaking Compaq, whose current market share is 17.9%.

Like most of its peers among technology stocks, EMC registered tremendous gains in 1999 and 2000. In fact, some of the best-performing technology stocks were in the storage sector. However, even these companies were not immune to the generally gloomy economic climate and have suffered badly from the massive cuts in technology spending by corporates.

Oct. 17, EMC posted a quarterly net loss of $945.2 million, its first loss in 12 years, and cautioned that it would likely not return to profitability until the second half of next year.

Likewise, shares of mighty EMC have fallen on hard times. The stock is currently trading at around 16.33, near the low end of its 52-week range of 10 to 92 per share, and a far cry from its all-time high of 104.99 seen just over a year ago. EMC has plummeted 78% since Dec. 31, 2000.

Sunnyvale, Calif.-based NAS pioneer Network Appliance Inc, whose market value is $5.27 billion, also recently announced results that were lower than a year ago due to weak technology spending and the economic downturn.

Last year, Network Appliance controlled 45% of the NAS market, but IDC expects EMC to overtake it in that market this year with $777.2 million in revenue, or 42% market share. Network Appliance's share is expected to drop to 32.5%, according to IDC.

Network Appliance stock, which was trading as high as 98 per share at this time in 2000, is now at 15.95. However, the stock has rebounded from its low of 6 in September this year.

Despite the poor near-term financial outlook of the sector, most analysts are uniform in the opinion that there's plenty of growth opportunity here.

The demand for increased storage capacity, faster systems, lower costs and more-efficient network management tools will probably make storage networking plans a top priority at many corporations. Analysts believe that storage networking equipment and software sales should continue to show strength even in an extended economic downturn and that storage vendors will be among the first to rise when economic visibility improves.

Furthermore, experts think that as SAN penetration is still in the early phases, new technologies such as SAN virtualization, advanced SAN management tools and security can create additional opportunities for market penetration and extension of existing technologies.

Such prospects explain why even through the downturn, storage networking has remained a popular area for venture capitalists. Of course, only time will tell whether these VC favorites will turn out to be winners.

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