VMware Still Has Upside Potential

| About: VMware, Inc. (VMW)


VMware announced a four-year strategic relationship with Arista Network.

VMware generated $5.21 billion in revenues in 2013, and has more than 500,000 customers and 75,000 partners.

VMware also signed a deal with China Telecom's cloud computing unit to build a hybrid cloud service that would be ready for launch next year.

VMware Inc. (NYSE:VMW), the leader in virtualization and cloud infrastructure, recently announced a strategic relationship with Arista Network. This four-year relationship will focus on developing innovative offerings, integrated SDDC solutions, and joint marketing of generally available Arista and VMware integrated networking solutions for VMware NSX. VMware is trying to improve its virtualization and cloud infrastructure to increase its customer base. VMware generated $5.21 billion in revenues in 2013, and has more than 500,000 customers and 75,000 partners.

Over the years, VMware has showed good growth numbers, and its per-share earnings grew 26.20% in the past five years. This is quite an impressive performance that has pushed the stock up. However, despite the good performance, like other tech stocks, VMware has been showing a volatile price trend. Currently, the stock is trading at $103.23 lower than its 52-week high of $112.89. In the last year, this stock has returned 23.84%, outperforming the S&P 500 and Citrix Systems (NASDAQ:CTXS).

Second-Quarter Earnings

VMware experienced strong growth across its businesses, and its results were ahead of analysts' expectations. The double-digit growth of 17% helped the company to generate $1.46 billion in revenues, beating analysts' estimates of $1.44 billion. Excluding revenues attributable to Pivotal and all divestures that occurred in 2013, revenues for the second quarter of 2014 increased 18% compared to what was reported in the second quarter of 2013. The increasing adaptation of VMware's products and services helped to deliver the growth. The software maintenance segment's revenues increased 20%, while on the other hand, the licensing segment's revenues increased around 16%. The company reported strong performance across all the business segments.

Source: Investor Presentation

Supported by top line growth, the net income for the quarter increased 2% from $343 million, or $0.79 per diluted share, in the second quarter of 2013to $351 million, or $0.81 per diluted share. Going forward, VMware's earnings may benefit from expansion in Japan and China, combined with the strategic relationships. The company's new product offerings may also add decent growth in the coming quarters. VMware's networking product, NSX, already has 150 customers and is on track to earning $100 million this year. On the other hand, the virtual storage is a more established market, and VMware's virtual storage product vSAN has 300 customers. This is impressive growth considering the fact that the company released virtual storage a few months ago.

VMware to Benefit from Enterprise Spending

The cloud and Big Data market is growing rapidly and will take years to reach its full potential. Enterprises around the world are increasing their cloud computing spending materially. The recent strategic moves could help VMware to avail these opportunities and maintain its growth pace. According to a recent report released by Pacific Crest, the build-out of private clouds could spark the next investment wave in 2015, with VMware becoming a beneficiary.

Cloud computing is still at its early stage and growing fast. In the IT sector, cloud represents just 3.8% of the $79 billion federal IT budget, and only 2.9% of the $1.42 trillion invested annually in software, services, and systems. This means there is significant room for growth, even if the competition increases. In that scenario, VMware is set to benefit because of its cloud offerings and expansion in Asia. Among enterprises surveyed, 28% plan to extend workloads to VMware now, compared to just 11% last year.

VMware's Product Portfolio is The Key

The new cloud offerings and new markets can significantly increase VMware's earnings. To do so, VMware recently made a deal with Soft Bank to bring its infrastructure-as-a-service "IaaS" public cloud offering to Japan, which will include computing, storage, networking, and security services. VMware is entering the Asian market, and Japan is the first county where the company will deploy its vCloud Hybrid Services.

VMware also signed a deal with China Telecom's cloud computing unit to build a hybrid cloud service that will be ready for launch next year. Once ready, it will support the delivery of IaaS in the Chinese market, while other services such as desktop and disaster recovery cloud services may follow at a later stage. VMware is currently in 30 cities in China, and this new deal will boost its customer base in the country. VMware is readying an introduction for its new cloud offerings and international expansion, and these initiatives will help the company to deliver what investors are looking for.


VMware has been good to long-term investors, because year-to-date this stock has gained 15.3%, but has more than tripled in the last five years. VMware is currently trading at an expensive valuation multiple, but its forward price-to-earnings multiple of 29.37 times is well-justified because of its earnings growth potential. In the next five years, it is expected that VMware will experience earnings growth of around 15.45%. Although future growth may slow down, it will still be strong enough to push the stock higher. The stock is recovering from a dip, but it is still lower than its 52-week high. So this could be an opportunity for an investor to add VMware to their long-term portfolio.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.