VMware And Pivotal To Help EMC Corporation

Dec.23.13 | About: EMC Corporation (EMC)

EMC Corporation (NYSE:EMC) is a global leader in enabling businesses and service providers to transform their operations and deliver IT as a service. The core of this transformation is cloud computing. Through innovative products and services, EMC accelerates the journey to cloud computing by helping IT departments to store, manage, protect and analyze information in a more agile, safe and cost-efficient way.

Though EMC has been providing efficient solutions, in the marketplace it has not been able to acquire a strong foothold. The year has been good for the tech industry which has outgrown the rest of the market. However, EMC has lagged behind and is struggling. Share value has been sluggish over the past year. Nonetheless, the next year brings us hope thanks to EMC's 80% ownership in VMware, the leading virtualization software company. I believe that VMware will be a big component in EMC's revival in the upcoming period thanks to the greater hype about cloud computing dominating the tech market.

In this article, I will focus solely on VMware and its operations along with Pivotal, the company that is helping EMC transition towards cloud computing. These two are crucial to the success and future viability of EMC.

VMware: EMC's Final Stop

VMware grew in its early phase by acquiring a technical lead in x86 server virtualization software to become one of the largest enterprise software companies. Although Microsoft is bringing increasing pressure to capture its market share, the company's industry-preferred management tools and strong partner relationships provide a competitive advantage that it could use to combat Microsoft and eventually bring profit to EMC on a long term basis. Along with that, the dominant presence of VMware provides a pre-established base for launching new products and services in the future.

Since VMware and EMC's cash balances account for over 60% of the company's market capitalization, an improvement in the subsidiary could prove good for EMC to an extent that we might be underestimating.

With regards to VMware's sustainability, cloud computing is a necessity for the upcoming needs of IT infrastructure. The conference on data centers by Gartner painted a good picture for VMware making it the leading candidate along with Microsoft to take a lead in the industry as the popularity of cloud computing grows. This is the view of analysts at UBS.

According to Brent Thill at UBS, VMware has an edge in virtualization technology and management tools whereas Microsoft is just catching up in terms of the suitability of the technology. In a survey regarding primary x86 server virtualization vendors' preferences, 94% supported VMware's vSphere.

VMware's Operations

Click to enlarge

Source: Presentation

VMware continues to provide support for EMC. It brought 24% of EMC's total revenue during the last quarter. Excluding Pivotal and all other divestitures, VMware's revenues has been growing by about 19% year over year on a quarterly basis increasing from 15% and 13% during the last two quarters respectively. The great performance has been a result of new product bookings which have increased their contribution to almost 40% of the company's licensing business. VMware's license revenues beat the high end of its guidance and grew by 15% this quarter on a yearly basis.

On the services front, VMware also continues to benefit from the customer loyalty it possesses as they continue to sign long-term contracts in excess of 24 months. The company earned $725 million from services this quarter which is up 20% from last year excluding Pivotal and divestitures.

Rising revenues helped VMware take advantage of economies of scale to defend its high operating margins. Looking forward, the company expects its operating margins to be in the range of 34%-35% for the next quarter. Also, the company intends to capitalize on the fast-growing mobile virtualization market and make a successful transition from the client-server environment to the mobile-cloud era of computing.

My point of putting exclusive weight on VMware to support EMC is justified by the operating results and future market movement. I believe the positive sentiment attached to VMware will continue to produce strong results for EMC that holds an 80% stake in the company.

Pivotal: the Transition Maker

Pivotal, the spinout of EMC and VMware has also introduced software last month to help its parent company gain position in cloud computing. It has already started providing results as revenue grew 21% year over year in the same quarter. Through Pivotal, the companies will shift their data centers to cloud servers run by companies like VMware, Amazon (NASDAQ:AMZN) and OpenStack.

Pivotal increases my confidence in its prospects for EMC by the recent confirmation of EMC's CEO to take the company public. The Paas platform, which will launch in 4Q13 by Pivotal is called by some 'the Android of cloud computing' and will allow EMC to grow at a faster pace. While this year is a preparation period where Pivotal prepares to gain a bigger share in the market, I expect to see good results from the beginning of 2014 onwards.

Conclusion

I didn't discuss EMC's performance in this article but on a quick note, revenue has been rising quarter over quarter and the company maintained revenue growth over the last few years greater than the industry. However, margins have been below industry levels. If you want to have a look, click here to see them.

Nonetheless, VMware and Pivotal provide huge potential to EMC and 2014 could be a turning point for this solution provider. Given the above prospects, I would recommend investors to keep a small position in the company as a part of their diversified portfolio.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.