Background/ Recent Actions
EMC (EMC) is the industry leader in both virtualization (55%) and cloud computing (25%). Since Mid-December 2012, EMC has been continually buying shares of VMware, (VMW) in low to mid 90's. Purchase thus far is roughly $45M, which is in addition to their 79.2% stake in VMW. EMC buyback of $600M (2/12) and VMW buyback of $250M(1/12) separate of above purchase (Source: EMC 10K).
Oppenheimer guided the stock's EPS down a penny from 52 cents to 51 cents/share and revenue down to 5.9B from 6B, creating low expectations for earnings and a chance for a surprise.
Virtualization: Companies without Virtualization are plagued by the need for many different types of servers under the traditional, "one server, one application" model. Examples of traditional servers are database servers, mail server, print server, web server, gaming server etc. Roughly 70% of IT budgets are used on maintenance of these servers, and these servers typically run at 5-15% capacity, creating high inefficiency in IT.
VMW most simply offers a world-class array of cloud-based IT services, a synergy with EMC, to reduce the complexity of managing IT through streamlined automation. More specifically, simplifying tedious day-to-day tasks such as provisioning, hardware maintenance, patching and capacity, incident, and performance management through policy-based automation. Grid computing enables companies with high intensity data projects to partition the projects to many different virtual computers thereby increasing the speed of the project. Grid computing enables a company to increase a computers capacity to ~85% by giving the computer chunks of larger projects when it is not busy working on its core functionality, thereby reducing the number of physical computers needed.
The main advantage of virtualization is that it reduces time needed for IT administrators to spend on maintaining servers. Historically, VMW services, often bundled with EMC data storage, save customers between 50-70% of total IT costs.
Grid computing is another attractive aspect of virtualization. It enables computers users to "donate" their computer's downtime to cancer research etc., by allowing the research center to use your computer when you are not using it. The other components of their business are licensing fees, de-duplication solutions, mobile virtualization, disaster recovery plans, and a security unit. All of which are expected to have high growth with IT expected to expand rapidly as extra security is needed to protect new IT.
Another emerging trend spearheaded by VMW is Mobile Virtualization. Mobile Virtualization enables multiple operating systems to run on a single phone. This enables users to access work-related data via a virtual mobile desktop. The important detail is that administrators can limit corporate access, thus maintaining corporate security standards and increasing the flexibility for employee access.
This standardization of mobile hardware creates an opportunity to make phones more cheaply by re-using software and hardware, thereby reducing development cycles. This can be huge for Android makers as they are trying to reduce costs by any means necessary to meet low price points desired in India, Brazil, and China. Validation of mobile virtualization is exemplified by signing on Motorola (MSI) in 2012 for Mobile Virtualization. This is in addition to clients such as LG, Samsung (SSNLF.PK), and Sony Ericsson.
The main focus of the article was to outline VMware's growth potential and business segments. Growth opportunities in Cloud Based IT are estimated by IDC to growth from $35 billion in 2012 to $73 billion by 2015. This is especially enticing as EMC is the clear leader in cloud computing and shows no signs of losing their market leadership.
Here is a useful video to help visually display many of the concepts I outlined, as there is a learning curve to understanding these highly innovative solutions to IT.
EMC (EMC) and VMW have world-class management, which is exemplified by synergistic acquisitions tightly in line with their current business models. Investment into EMC is investment in some of the most rapidly growing industries, which are big data, virtualization, IT security, and software defined networking (SDN). VMW just acquired Nicira, to fully expand their SDN portfolio as well as a strategic move to acquire the 70 of the best SDN engineers in the field. A strong competitive advantage arises from their current market leadership, the depth of engineers they have, and a proven track record in the high tech industries. This stock is appealing because it delivers diversified growth at a relatively low multiple.
There are a few catalysts emerging that are likely to materialize into significant growth for EMC, some of which I believe are not fully incorporated into EMC's current share price at roughly $24. EMC partnered with Lenovo (LNVGY.PK) for joint-venture in China selling storage equipment to small and mid-sized businesses, which I outline below.
A major catalyst for VMW is that they lowered the minimum fees earned per client from $10,000 to $6,000 to gain more clients in 2012. I do not believe this will have material impact on VMW's margins, as the majority of their costs of business are R&D to continue innovation and the human capital of their engineers that do not increase significantly with scale. The other smaller catalyst was that VMW launched its cloud computing and big data analytics courses in India.
Deal with Lenovo
EMC announced a deal on August 12th with Lenovo to bring co-branded network attached storage to business customers. The companies forged an OEM and reseller relationship in which Lenovo will provide EMC's industry-leading networked storage solutions to its customers, initially in China, then expanding into other global markets
This created a JV to provide Network Attached Storage (NAS) systems to small/medium businesses and distributed enterprise sites. Lenovo is an IT products/ IT services company based in Hong Kong with roughly a $10 billion market cap that operates in 160 countries. Lenovo has shown strong growth since 2009, which I believe will continue with their strategic partnership with EMC.
EMC recently outbid Cisco (CSCO) for Nicira, which specializes in SDN, software based method to control wireless connectivity such as bandwidth, capacity, access etc. A main advantage of SDN is moving network management, such as directing traffic or shrinking latency, to a software based controller instead of expensive and less flexible switches provided by CSCO and Juniper (JNPR). This saves money by reducing hardware and saves money in IT labor by making configuration changes simpler
The Nicira investment brought AT&T (T), Rackspace (RAX), eBay (EBAY), NTT Docomo, Fidelity, and even Google as key customers to VMW. It is estimated that Nicira investment boosts the addressable market in virtualization from roughly $30 to $50 billion by 2015 (through improvements on virtual SDN platform). Virtual Networking is widely regarded as a "guaranteed" movement in effort of hardware reduction and a "green alternative" that benefits the company and the environment. Both EMC's and VMware's products can most simply be viewed as a way to outsource IT maintenance to a specialist such as EMC/VMW to increase focus on core business operations. The success of acquisitions by EMC is exemplified by EMC bought their stake in VMW in 2003 for $625 million, which is now worth over $30 billion.
Disclosure: I am long EMC.