Why is Data Domain such a hot acquisition candidate?

It almost looks like a bidding war for Data Domain (DDUP). First a bid from NetApp (NTAP), then a bid from EMC and now a revised bid from NetApp.

First, what does Data Domain do?

Here is summary of the profile from Yahoo Finance: "Data Domain, Inc. provides deduplication storage appliances for disk-based backup, archiving, and network-based disaster recovery. The company's appliances reduce the storage of redundant copies of data within enterprises. It also offers Replicator software, which allows enterprises to utilize wide area network vaulting for offsite disaster protection and recovery; and a capacity-optimized Virtual Tape Library software option that emulates multiple tape libraries over a fiber channel interface, as well as integrates with an enterprise's existing backup infrastructure."

Translation: Data Domain's hardware and software, by reducing duplication and redundancy in a company's data and documents, lessens storage requirements and thereby cuts costs. The company also provides software that facilitates different ways of backing up important data and documents.

Why buy this company?

So now that we know what Data Domain does, why is it suddenly such attractive buyout candidate?

First, Data Domain is a natural fit for both would be acquirers. For a change, it would appear there is truly a synergistic benefit that would result from putting Data Domain together with either NetApp or EMC.

NetApp and EMC are essentially head to head competitors in the enterprise storage sector. In other words, both companies provide hardware and software that organizes massive numbers of disk drives into some kind of structured system that enterprises can use to stash their ever growing amounts of data. Both companies work to extend that basic business concept to include different kinds of data backup strategies, data security and data management.

The functionality that Data Domain brings to the table, therefore, is a perfect extension of what NetApp and EMC are currently doing. Data Domain fills a hole in the product suites of both NetApp and EMC, neither of whom are recognized as leaders in data deduplication and reducing redundancy.

Is Data Domain a bargain?

I took a quick look at some of the financial data at Yahoo Finance and the quick answer is a resounding "No!" Now that the stock price has soared as a result of the buyout offers, Data Domain has a trailing PE over 100 and a forward PE over 50. PEG is 2.7 and price to sales is over 6. Data Domain would never be confused with a value stock at its current price.

On the other hand, the firm is cash flow positive and profitable. Revenue from support and services has been steadily increasing though revenue from product sales has taken a hit in this down economy. There is virtually no debt. Financially, the company is in decent shape with a reasonably strong balance sheet.

Given that Data Domain is no bargain, it is clear that both NetApp and EMC are looking for the acquisition to result in a whole that is greater than the sum of the parts. NetApp and EMC have much larger market caps than Data Domain and a deeper penetration into the enterprise. The acquirers clearly expect that they can more efficiently and profitably sell Data Domain products and services as part of their pitch to CIOs than Data Domain can on their own. Furthermore, there is no doubt that redundancies and overlaps will result in costs being taken out of Data Domain, no doubt partly through reduction of headcount.

Conclusion --

So many mergers seem ill considered and turn out to be mistakes but this one actually looks like a great fit. The eventual winner of this acquisition contest should be able to benefit as long as they don't overpay. That, unfortunately, is a real possibility if this bidding war continues.

Disclosure: no positions