The last time I wrote about VMware (VMW), I was expecting the share price to decline. Instead, the company reported solid earnings and the share price increased. But, the share price has started to decline again, and that adds evidence to the idea that VMware could be poised to decline substantially in value. The solid earnings report is being met with profit taking or short selling.
In this report, I extend the previous analysis with longer term forecasts, valuations and returns on investment. I continue to like VMware as a company, but I think the valuations are too high. I don't think the 10% - 19% CAGR between now and the end 2015 or early 2016 is worth it.
Given the facts of the situation, I will continue to keep VMware on my watchlist, but I will not commit capital given what I perceive to be a substantial amount of valuation risk.
In this section, I will present forecasts for VMware and Citrix (CTXS), a competitor and good peer company comparison; I will then use those forecasts to compute valuations and estimated returns on investment. VMware is the better investment opportunity, but it is overvalued.
The model predicts revenues between $4.7 billion and $5.66 billion for this fiscal year; VMware is reporting revenues between those run rates. At the low end of the 2015 revenues forecasts, the CAGR would be 7.92% and 13.57% at the high end. Both CAGRs are calculated from the end of fiscal 2012. For fiscal 2018 the CAGRs are 8.28% and 10.5%. The model forecasts high single digit to low teens revenue growth through 2018.
VMware is trading at 7.2 times trailing sales. The forecast should be more accurate for 2015 than for 2018; consequently, I will model the valuations using 2015 revenues. At the low end of the range, VMware would be worth $41.673 billion and $48.571 billion at the high end. The current market capitalization is $34.4 billion. So, the CAGR at the low end would be 10.07% and 18.83% at the high end; both are solid returns on investment.
The returns on investment assume, among other things, that VMware continues to trade at 7.2 times sales. That is a potentially dangerous assumption as the company could trade at a lower multiple which could result in a negative return on investment. Further, VMware could face revenue headwinds from increased competition which could decrease the revenue CAGRs to the mid to high single digits or lower.
As a measure of risk, if VMware trades at 3.5 times sales and the low end of the 2015 revenue forecast, the market capitalization would be just over $20 billion.
Citrix, a competitor of VMware, is forecasted to post fiscal 2013 revenue between $2.619 billion and $2.866 billion, which is inline with the current run rate. Moving on to the fiscal 2015 revenues forecasts, the low end suggests a CAGR of 5.54% and 8.97% at the high end; both forecasts are from the end of fiscal 2012. For fiscal 2018, I have CAGRs of 6.01% and 7.67%. The model forecasts mid to high single digit revenues growth through 2018, which is slower than VMware's forecasted revenues growth rate.
I'm going to use the 2015 revenues forecast to value Citrix, which is trading at 4 times sales. The valuation range would be $12.16 billion to $13.38 billion with a current market capitalization of $11 billion. Consequently, I would be looking at a CAGR between 5.14% and 10.29%. The high end of the forecast would be a good ROI, but the low end is too low for me.
Comparing the companies, VMware could have the higher ROI if the sales multiple remains constant, but Citrix is cheaper on a sales multiple basis and may have less multiple risk. Readers should note that I excluded the lower portion of the revenue forecast range in favor of a midpoint and upper end model; I felt that the low end of the forecasted distribution was too low to include in a forecast at this point.
In terms of profitability, VMware is the more profitable company; Citrix's profitability is deteriorating. At this point, I would have to favor an investment in VMware over an investment in Citrix, but VMware's valuation on an absolute basis worries me. Next, I will do some analysis from a portfolio management perspective.
In this section, I will conduct some technical analysis of the share prices and model a 52-week price target. At the end is a conclusion based on the portfolio management analysis and valuations. After the valuations section, I decided that I would not purchase the shares of either of these companies, but I will continue the analysis because it could be useful.
In terms of technicals, there is a head & shoulders top on the monthly chart of VMware that is suggesting a price target of at least $40 per share. Using this forecast, VMware would be trading at 3.5 times current TTM sales. Coincidentally, that was what I considered a close to worst case scenario when I was modeling the potential ROIs; I can't dismiss the facts, especially when there is an intuitive coincidence. Additionally, Citrix is trading in a bear market of primary degree and a bear market of intermediate degree. Simply said, the charts of both stocks suggest being bearish.
Continuing to the next leg of the analysis, I will compute 52-week price targets for the companies because at some point they will come in handy. The model predicts a 52-week price target for Citrix of $89.36 and $113.06 for VMware, but I expect those will be revised lower because of factors not modeled into this forecast.
From a portfolio perspective, I won't invest in either of these companies. The valuations also suggest the same investment stance. Given the economic environment and underlying fundamentals of the businesses, I'm not going to short sell either company. On the bright side, if the sell off does materialize, it would provide an excellent buying opportunity.