Strong Growth in VMware’s Software Maintenance Revenues Drives Stock Up

Includes: CTXS, MSFT, VMW
by: Trefis

VMware (NYSE:VMW), a pioneer in the desktop and server virtualization software industry, recently released its first quarter earnings with a reported 35% year on year revenue growth . While the license revenues improved by 22%, the more promising show was presented by maintenance and service revenues which grew over 50%.

As a result we have raised our expectation of VMware’s maintenance revenues for the full year 2010 which we forecast in our model as percentage of total license revenues. We have upgraded VMware’s stock price from previous estimate of $55 to $62 in order to incorporate the growth in maintenance contracts.

Below we discuss the importance of virtualization software to VMware’s stock and how it benefits from increased maintenance revenues.

Virtualization Software is 88% of VMware Stock

VMware competes with the likes of Microsoft (NASDAQ:MSFT) and Citrix (NASDAQ:CTXS) in the virtualization software domain and leads the market with approximately 46% share globally. This high market share is a result of its superior and broader product portfolio which includes offerings for desktops, servers and network storage systems.

We estimate that virtualization software constitutes 88% of the $62 Trefis price estimate of VMware’s stock.

Growing Maintenance Revenues Good for VMware’s Stock

VMware, like many software companies, generates revenue primarily by selling new software licenses to its customers. The second stage revenue is generated when the license period expires and these customers sign up for maintenance and service contracts at a lower fee.

Renewal of maintenance contracts is an indicator of high customer satisfaction levels associated with the vendor’s product. VMware’s renewal bookings were up 56% in Q1 2010 compared to Q1 2009 reflecting the high growth opportunity for its maintenance revenues.

VMware’s maintenance and service revenues as a % of licenses sold have risen sharply from a mere 19% in 2005 to 73% in 2009 and we expect it to reach 93% in 2010. This positive outlook has resulted in 13% upside to previous Trefis estimate of $55 for VMware’s stock. You can modify the forecast below to see the further upside to stock price if VMware’s maintenance and service revenues keep growing at high rates.

Disclosure: No positions