EMC Corporation (EMC) is a provider of data storage solutions that has sold off lately on concerns of a slowdown in orders, mostly related to the temporary government shutdown. However, now that this impasse in Washington has been temporarily resolved, at least until the next manufactured crisis out of DC, I believe EMC's weak quarter actually represents a tremendous buying opportunity.
One major reason is that this allows more time for the company to continue buying back its own shares at discounted levels. Despite the supposedly soft sales, EMC has still generated $3.7 billion in free cash flow so far this year, $2 billion of which has gone towards share repurchases. This is more than halfway to their goal of buying back a total of $3.5 billion worth by the end of June next year. The longer the share price stays low, the more shares they can retire before then for the benefit of current shareholders, who will thus retain a larger ownership interest.
Also, the temporary slowdown in their traditional storage business has obscured continued strong performance out of some of their other divisions, notably VMware (VMW), the company's publicly traded but still majority owned subsidiary. VMware reported strong revenue and earnings growth while giving solid guidance for next year, as noted in this article. The market initially reacted very favorably to these results, before selling off slightly as expectations were tempered by EMC's own earnings report the next day.
However, VMware still trades at a $36 billion market cap, 80 percent of which is still owned by EMC. This means EMC retains a nearly $29 billion stake in a fast growing company that the market is not giving it enough credit for. This is not even including a separate equity stake in another joint venture between the two companies, where each will contribute certain assets to create a faster growing enterprise called "Pivotal" that will focus on providing a cloud based platform for companies to use to develop applications, including mobile apps supported by another recent acquisition called Xtreme labs.
Considering that EMC also ended the last quarter with $17.5 billion in cash and investments, we begin to get a sense of the value contained in the company compared to its current market cap of $49 billion. Excluding the cash on the consolidated balance sheet attributable to VMware, since that is already reflected in its own market cap, EMC has a net cash and investment balance of about $5.6 billion after subtracting off its long term and convertible debt.
Deducting the market value of the VMW stake and these liquid assets, EMC's core business is receiving an inferred valuation under $15 billion, despite being on target to generate $2.9 billion in net income and $5.5 billion in free cash flow for 2013. Even conservatively assuming that VMware will contribute half of these consolidated numbers, likely high but necessary since they don't break out guidance by segment, we arrive at the estimation that EMC's legacy business is only receiving a P/E ratio of about 10 and a Price to FCF ratio of about 5, both extremely low for a still fast growing tech company.
Given that EMC remains committed to accentuating and returning this value to shareholders through buybacks and a recently instituted dividend, I believe the company represents a low risk value proposition with a large margin of safety. Also, it offers additional upside through the ownership interests in VMware and other faster growing enterprises, which would likely unlock significant value if completely spun off.
Although I am already a holder of EMC stock, I will be looking to add to my position if EMC remains depressed compared to their still bright business prospects in general and VMware in particular. I think the company is very well positioned to both lead and benefit from the continued trends of Big Data, virtualization, and cloud based information technology and application solutions. Today's price represents a substantial discount that I hope both the company and shareholders take advantage of to acquire more shares in this great business.