An Unloved Store of Value by Tiernan Ray
Summary: VMware (VMW) didn't disappoint when its long-anticipated IPO went off last Tuesday; shares rose 76% from their $29 pricing on the first day of trading. By week's-end the stock was up 92% at $55.55 a share, but investors weren't showing much love for shares of its parent EMC Corp. (EMC), which continues to own about 86% of the virtualization company. EMC shares tumbled 4% on the day of the IPO and remained there as the week came to a close. But investors looking to own a piece of VMware are missing out on an opportunity to do so much cheaper through EMC: Buyers of EMC get VMware at a P/E multiple of 42 rather than 86 for the outright purchase of VMware. Add in the possibility of 17% earnings growth for the rest of EMC, and its shares could be 20% higher or more over the next year. Excluding VMware, EMC's core business is worth about $27B, leaving the remaining $11B in market value to the EMC stake. Based on current prices, that should be $18B -- meaning EMC investors are getting VMware at a 40% discount. With analyst expectations of 59% profit growth at VMware for the next three years and 50% annual sales growth, one analyst believes VMware could add as much as five percentage points to EMC's annual revenue growth. One portfolio manager says EMC ($18.29) should be a $22-$23 stock because it will grow revenues at a higher rate than and therefore deserves a higher multiple than the 15x that Hewlett-Packard (HPQ) commands. Investors may be marking down EMC's VMware stake because they believe it is illiquid since EMC likely won't sell any shares before 2009 to avoid taxes. Others think there might be a better entry point after the VMware hype quiets down. Nevertheless, Barron's suggests getting into EMC now to position for the growth in VMware.
Earnings call transcript: EMC Q2 2007