Why Shorting VMware is a Mistake

I am still trying to understand the assumption behind the shorting crowd's continued insistence and pretension that somehow VMware's (VMW) stock is about to implode.

From a basic analytical stand point: VMware, the hottest initial public offering since Google (GOOG), hits the market August 14th 2007 after feeding the street with staggering growth numbers. VMware's financial results to date have been nothing short of impressive. Revenue-wise the company posted in fiscal 2003 revenues of $100 million, followed by $218 million in 2004, $387 million in 2005, $709 million in 2006 and $704 million in 2007. Lastly, 2008 projected revenues stand at $1.2 Billion and could even push to $2 billion by end of fiscal 2008. In other words, there is no denying of this company establishing itself as a rapidly growing cash flow machine besides its compelling growth prospects.

In the midst of the subprime debacle, falling stock prices and market volatility this last correction, shares of VMware still jumped to an impressive 76%. Its market valuation rose to $22 billion in just two days alone. Stock recently reached new highs of $80.15 giving VMware a $26.17 Billion market cap and making it the second biggest Silicon Valley-based software company valuation-wise.

Based on these facts, are shorts then selling this company on grounds of weakness? I would argue that approaching VMW from a shorting perspective at this point is naive. Nothing against the shorting crowd. I am only trying to find out how objectively we can establish a baseline valuation for this company and come to the conclusion of implosive prospects when every inch of VMware' structure and its current revenue trajectory only projects growth.

Disclosure: Author has a long position in VMW

Comments

[volleyballmaniac]

They are shorting based on over-valuation, not on market weakness.

If you want a basis of valuation, take a look at its paltry earnings of 128 million in 2006, and realize that this is only a 25% increase from 2005.

At a current P/E of 216, it would take 5 years of 25% Earnings growth just to pull this stock's P/E out of the stratosphere.

Are you willing to sit around for 5 years while it does so? Not me.

And with all the great competition coming after them (Microsoft, IBM, and many other startups), you can't expect their margins to be so fat for very much longer.

At VMW's current price, it is way over-bloated.

[Futuresfairvalue]

First and foremost and very respectfully here, if read carefully ; article never alluded of market weakness constituting a shorting basis on this ticker, far from it. My whole point rather, was to challenge objectively, the correlation btwn - shorting a solid fundamentally stock such as VMW with its continued uptrend under shaky market conditions, and the pretension of pps unjustifiably high based on standard measures. My personal take is again, that shorting from the angle I just described would not be a viable option from an investment perspective. Day trade/wise...absolutel... one could be on the right side of the trade and scalp it to profitability a few times however, we are talking investment.

In relation to the valuation argument:

Rather then calc'ng only 25% increase btrw fiscal '05-'06 which is still a very significant and positive number......., I'd be nice to accumulatively state what the growth %wise has been, btwn 2003 to present......$100 million in revs 2003 with almost $2 Billion projected in 2008. Yes, explosive is the right word. Also Googles next 5 yrs growth estimates stand at 33.65% while Vmware's stand at 60%. Let's say 1.5 Billion will be added to books in 2008 based on 60% estimates, revenues should reach the $12 Billion mark by 2012.

Imho, to conclusively rate stock as 'over-valued' , based only on its multiples..I'd say ; it is not a sound counter-argument since noone can 100%, base an investment decision on this measure alone with all its already known susceptibilities.

My take on Vmware is that ; fair value rather than anything else, should be determined in terms of its ability to maintain its monopoly position at this point along with its pricing premium, if it is to face competition in the very near future. They are in a monopoly position since only one seller and way too many buyers. Over 20,000 companies now running VMware technology, including 99 of the Fortune 100 companies...[they will be omnipresent at some point if they go with this rate.]

Competition/wise, Microsoft currently offers only basic virtualization offerings. To say that somehow, MSFT poses at these present stage in their virtualization efforts "great competition" honestly, it is analytically misinforming.

It is true MSFT plans to introduce a more robust enterprise version in fiscal '08, but what we are not mentioning here, is fact of new offering still expected to be lacking in functionality relative to VMware’s comprehensive and constantly improving product set.

Imo, this is a solid company and it will continue to reflect its standing pps/wise.

[DanielJacome]

people who short based on valuation only always get to the party only and pay the price if they dont have the gas to stick around. Careful shorting VMW if you don't have the long term resolve to get thru it all.

Better stocks to short: weakest houses in crappy neighboroods.

I say look at: (homefurnishings) -- RSTO
( toys) -- LF, RCRC
( newspapers) -- LEE

[Greg Harris]

My guess is that the shorts probably have some sort of pair trade with EMC, because EMC is relatively cheap and owns massive portions of VMWare. If that's not what they're doing, I agree, it's a dumb trade. While I won't say it'll lose money, they're in for a potentially disastrous lesson in what extreme revenue growth coupled with high operating leverage can do to change the earnings picture in a real hurry.

[techy]

here is my overly optimistic estimate (i am an IT guy, an early adapter of VMware, i know how much we spend on Microsoft and how much we will spend on VMware, extrapolate data from both, which will give a upper limit to vmware)
revenue income
Q1-2007 258.69 41.00
Q2-2007 296.82 34.22
Q3-2007 350.00 59.50
Q4-2007 400.00 72.00
206.72--2007 income
Q1-2008 500.00 100.00
Q2-2008 650.00 130.00
Q3-2008 800.00 160.00
Q4-2008 950.00 190.00
580.00-- 2008 income
Q1-2009 1,100.00 220.00
Q2-2009 1,200.00 240.00
Q3-2009 1,250.00 250.00
Q4-2009 1,300.00 260.00
970.00 -- 2009 income
Q1-2010 1,350.00 270.00
Q2-2010 1,400.00 280.00
Q3-2010 1,450.00 290.00
Q4-2010 1,500.00 300.00
1,140.00---2010 income
Q1-2011 1,550.00 310.00
Q2-2011 1,600.00 320.00
Q3-2011 1,650.00 330.00
Q4-2011 1,700.00 340.00
1,300 --- 2011 income