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Shares of VMware (NYSE:VMW) jumped up in after-hours trading on Monday after the virtualization infrastructure solution provider reported a solid third quarter earnings report. This was accompanied by a solid outlook for the remainder of the year, and into 2014.

I remain on the sidelines. Given the fast developments in the cloud, I find it hard to judge which company will end up with a leading platform and just how much cloud could become "commoditized" in the coming time.

Third Quarter Earnings

VMware generated third quarter revenues of $1.29 billion, up 13.7% on the year before. Note that excluding divestitures, including that of GoPivotal, revenues would have increased by some 19%. Reported revenues came in line with consensus estimates.

Net earnings advanced by 66.2% to $261 million. Diluted earnings per share rose from $0.36 to $0.60 per share. Non-GAAP earnings rose from $0.70 to $0.84 per share, beating consensus estimates by two cents.

CEO Pat Gelsinger commented on the third quarter performance, "VMware continues to build momentum globally, because we are uniquely positioned to help our customers transform to the mobile-cloud era of computing."

Looking Into The Results

Reported revenue growth of 13.7% was driven by license revenue growth. Revenues from licenses rose by 14.9% to $564 million as service revenues were up by 12.8% to $725 million.

As a result of solid revenue growth and operating leverage, VMware boosted operating income to 22.3% of total revenues, up 560 basis points on the year before.

Looking Into The Fourth Quarter And 2014

VMware already gave a quick peak into the prospects for 2014. Basically, VMware guides for annual revenue growth of around 15% for next year. This means revenues are pretty much expected to grow at the same pace as 2013.

Note that fourth quarter revenues are seen between $1.45 and $1.48 billion, which compares to consensus estimates which stood around $1.48 billion.

Valuation

VMware ended the third quarter with $5.84 billion in cash, equivalents and short term investments. VMware has $450 million in notes payable to EMC Corporation (NYSE:EMC), for a net cash position of around $5.4 billion.

Revenues for the first nine months of the year came in at $3.72 billion, up 12.4% on the year before. Net earnings advanced by 25.7% to $679 million. At this pace, annual revenues could come in around $5.2 billion, as earnings could come in between $900 million and a billion.

Factoring in gains of 11% in after-hours trading, with shares trading around $92 per share, the market values WMware around $39.5 billion. This values operating assets of the firm around $34 billion, the equivalent of 6.5 times annual revenues and roughly 35 times annual earnings.

VMware does not pay a dividend at the moment.

Some Historical Perspective

Shares of VMware were sold to the public in 2007 when EMC divested a 10% ownership in the company at $29 per share. Note that in 2006, VMware reported revenues of just $709 million.

Shares quickly rose to highs of $120 per share in 2007 after which they fell to levels of just $20 in 2008 and 2009. Shares steadily recovered to highs of $115 per share in 2012. Shares fell back to lows of $65 in July of this year to rise to $92 in after-hours trading.

Between 2009 and 2012, VMware more than doubled its annual revenues from $2.0 billion to $4.6 billion. Net earnings nearly quadrupled to $746 million in the meantime.

Investment Thesis

VMware is happy with the third quarter performance, seeing strong demand for new solutions, including the software-defined data center.

VMware aims to "liberate" resources from the client-server world, to create a mobile-cloud world. Just recently, the firm held its VMworld 2013 meetings in North America and Europe, with a combined attendance of over 31,000 attendees. Those who participated in the meeting saw demos of new technologies like VMware NSX, VMware Virtual San and VMware Cloud Suite 5.5.

VMware, once a spin-off from EMC, can still count as the former parent company as a major shareholder in the firm. VMware's virtualization software, which allows users to combine multiple applications on a single machine, is seeing strong secular demand. The newest trend, also for VMware is the hybrid cloud, combining private and public clouds together. In this system, key data and applications will be stored on the private system while public systems allow for easy and cheap access to non-core assets.

As we have seen recently with some prominent outages, including that of Amazon.com's (NASDAQ:AMZN) Web Service, cloud is not just about costs alone. Crucial is also security of information, outages and compatibility with tools and software. To aid customers in this transition, WMware acquired Desktone to help them move desktop infrastructure in the cloud.

Despite the significant cash balances, VMware is not paying out any dividends. The Company did spend $90 million to repurchase some 1.2 million shares over the past quarter, retiring shares at a rate of merely 1% per annum.

Back in March of this year, I last took a look at VMware's prospects. Shares were trading around $85 at the time, as the re-acceleration of the long term revenue guidance provided comfort for investors.

At the time EMC and VMware gave more information about the "Pivotal" initiative which has been announced a year ago, to benefit from the "big data" theme and cloud demand. Both company's will each contribute operations, staff and resources into the new entity in which EMC will hold a 31% equity stake.

Despite placing some of VMware's fast growing operations into the Pivotal initiative, revenue growth from the remaining activities remains very solid. Back in March I concluded that the valuation multiples are still quite steep, while the company took actions to focus on core operations, moving ahead with the "Pivotal" project.

Basically, VMware is guiding for annual revenues north of $6 billion for 2014 on which earnings should come in around $1.2 billion. Note that the $40 billion market valuation excludes nearly $5.5 billion in cash and equivalents, and the stake in the Pivotal project. As such revenue multiples are not even out of line for a cloud-provider. While GAAP earnings multiples are still sky high, VMware is managing to report earnings from its operations. This is in contradiction to many of its competitors.

In March I concluded to remain on the sidelines, finding it hard to see how future developments will impact VMware's competitive position in this fast changing landscape. As competition might result in a risk that cloud becomes commoditized, I reiterate that stance.

Source: VMware - Solid Quarter, Solid Outlook