VMware (VMW), the network computing and virtualization software seller, has built its stronghold in the industry over the past few years. The company has grown tremendously over the years reporting higher turnovers year after year and now boasts of 80% market share in the virtualization industry. The business model has helped drive net income margins higher due to the high maintenance and upgrade revenues accounting for a third of its total. The company has re-invested all profits into the company rather than distributing dividends to maintain the high growth. With little debt and ever growing shareholder's equity, the company is under no external pressure for capital.
VMware , like any other technology firm, has grown at a rapid pace despite the economic downturn in US and Europe. It has more than doubled its revenues in the last 5 years from $ 1.9 billion in 2008 to $ 4.6 billion in 2012. The company boasts of a very high gross margin of 84% but the continuing high salary expense is dampening down the operating margins of the company which are at 18.9% currently. The net income of the company has grown just like the revenues as the net margin seems to be fairly constant over this period. From being just $ 290 million in 2008, net income has grown to $ 745 million in 2012.
Being a high growth company, the management of VMware has been investing the earned profits back into the company which have resulted in a huge increase in the cash & cash equivalents. The company just recently started investing its cash into short term investments in order to make benefits for the shareholders. The short term investments have now outgrown the cash with the company as the requirement for working capital hasn't increased drastically. With growth in its business, the amounts of receivables have also increased but there hasn't been much increase in the accounts payable.
Even then, the company has managed its working capital needs effectively without taking on much debt. The company has never taken a short-term loan for its working capital requirements and has managed it through its cash reserves. The long-term debt stands at $ 450 million on which the company has been paying interest for several years. The company has issued equity at different points of time in the last few years but the primary source of increase in the value of the shareholder's equity has been the huge return it has been earning.
VMware's profits year after year are reflected by the consistent increase in operating cash flows. The cash earned through operations has been mostly used to purchase short term securities in order to earn additional income for the shareholders. The company also frequently repurchases its shares from the market. This has added impetus to the EPS of the company which has been growing at a fast pace.
VMware is the major player in the virtualization system industry with nearly 80% market share but has been posed a threat by Microsoft's virtualization software in the recent times. But this company is on the right track with its recent acquisition of Zimbra, adding to the service offerings of the company. Citrix systmes Inc. (CTXS) is another competitor of VMware as it deals in desktop virtualization. The company out rightly dominates the virtualization industry with the likes of even Apple (released a product called Bootcamp to run Windows on Intel based Macs) being unsuccessful to compete with VMware. Other competitors like Red Hat and Novell do not hold more than 2-3% market share.
The company is valued at a P/E of 42.3 which is much lower as compared to its competitors in the technology and system software verticals. The P/B ratio of 5.2 is also lower than its competitors whereas other competitors with ROE similar to that of VMware are trading 13-15% higher. The company hasn't reached the multiples as high as its competitors. It has grown astonishingly in the first decade of the new millennium and is expected to keep going at its current pace. The company has a lot of room for growth but faces fight to maintain its share in the industry. The company might look at inorganic options for growth like in the case of Zimbra. Being valued much lower to its competitors, I would recommend buying VMware as it still has enough room for growth.