EMC (NYSE:EMC) announced its second quarter earnings on July 23, reporting a 5% year-on-year growth in net revenues to $5.9 billion. The company's services revenues rose by almost 9% over the prior year quarter to $2.6 billion, while its product revenues stayed flat at about $3.3 billion. Much of the growth was driven by VMware (NYSE:VMW) (+17%), Pivotal (+28%) and RSA Security (7%) while core information storage revenues remained nearly flat at $4 billion.
EMC's market share in external storage systems declined from 30.2% in Q1 2013 to 29.1% in the first quarter of 2014, according to a recent report by IDC. This was the first quarter since 2008 in which EMC's market share declined year-over-year. EMC's revenues from external storage systems in Q1 declined by almost 9% while the industry-wide decline was about 5%. However, EMC's revenues in Q2 grew higher than the industry average, due to which the company gained share in the market.
Weakness in its core business led to market speculation prior to earnings about EMC spinning off VMware and Pivotal. The Wall Street Journal reported that external pressure from EMC's large institutional investors could lead the company to spin off some of the fastest-growing businesses within the company such as VMware and Pivotal. However, EMC's management refuted the speculation and stood by its "federation" business model, wherein some of the acquired companies operate as separate entities while they still collaborate on products for large clients. The company believes that its current setup is ideal for growth for both EMC and the acquired companies.
We have a $30 price estimate for EMC, which is roughly in line with the current market price.
Key Areas Of Growth:
- Emerging Storage
EMC's Emerging Storage products such as XtremIO, Isilon, Atmos and VPLEX were largely responsible for the growth in hardware sales during the past few quarters. The Emerging Storage sub-segment grew by 51% year-over-year (y-o-y) in Q1 2014, which the company attributed to a strong customer response for these products. Despite strong y-o-y growth, the revenues generated by emerging storage solutions stayed flat over Q1. The company attributed this to intermittent demand for some large individual orders. The company expects strong growth for emerging storage solutions on the back of solid demand for software-defined storage, Big Data analytics, cloud storage and flash arrays in the coming quarters.
VMware's revenues grew by 17% y-o-y to $1.45 billion for the June quarter with growth coming from both product licenses revenues (+16%) and services revenues (+18%). However, VMware's gross margin within EMC declined by 180 basis points over the prior year quarter to 87.8%. The decline in VMware's margins led EMC's overall gross margin to decline by 40 basis points to 62.1%. EMC has invested over $6 billion in acquisitions and internal developments since 2012, of which a significant portion was attributable to VMware related products. These acquisitions included software-defined networking leader Nicira and mobility management leader AirWatch. All the acquisitions will show up as losses on the income statement this year. However, management believes that margins are likely to improve in the future quarters (read: SDN, Hybrid Clouds And AirWatch Help VMware Post Strong Q2 Results).
Pivotal is among the fastest-growing divisions within the company, with 40% y-o-y growth in the first quarter. Although the growth rate was lower than the previous quarter at 29%, the number of orders rose by over 50%. Additionally, Pivotal's margins expanded from the March quarter. Pivotal's platform consists of new generation data fabrics, application fabrics and a cloud-independent Platform-as-a-Service to support cloud computing and Big Data applications, which have started gaining traction among customers. Management mentioned that some of Pivotal's growth may not be immediately realized in the numbers since it is building out a subscription-based revenue stream, which is likely to be beneficial in the long run.
- RSA Security
RSA Security, EMC's information security division, grew by over 11% to almost $1 billion in 2013. The growth continued in the first half of 2014, but the rate of growth was lower than 2013 at about 6% y-o-y. The information security industry is growing, with customers allocating more of their security budgets to intelligence-driven analytics, where RSA Information Security excels, rather than static prevention.
Disclosure: No positions