EMC: A Great Way To Profit From VMWare

Lately, it seems that you can’t go a day without reading another article touting the success and potential of VMWare (VMW), the recently IPO-ed software virtualization company. VMW has skyrocketed from its August IPO price of $29 to its current perch at $84. Although the growth prospects of VMWare are tremendous, it’s not the type of stock I feel comfortable trading- its forward PE of 93 and a 30+ P/S don’t leave much room for error.

However, the recent run-up in price and continued positive momentum (4 new analysts came out with “Buy” ratings on the stock Monday) have created a less risky way to play the stock, one that also capitalizes on an apparent market inefficiency. VMWare was spun-off from EMC (EMC), the computer software and infrastructure giant. EMC retains 87% ownership in VMWare, a stake currently worth about $28B.

That means you can purchase the rest of EMC for less than $14B, a bargain for a leading technology company with a couple billion in net cash and $12.9B in expected 2007 revenue. And EMC gives you another way to play the success of VMWare and virtualization- the company makes a suite of products designed for optimization of VMWare environments.

Oddly, although the value of EMC’s stake in VMWare has risen nearly $19B since the IPO, the market cap of EMC has risen only $3B. Yet there haven’t been any other public negative catalysts that could account for EMC’s depressed share price. A similar phenomenon marked the McDonald’s (MCD)-Chipotle (CMG) IPO. Although CMG soared, shares of McDonald’s, which owned a controlling interest, languished for months. Eventually, as McDonald’s continued to unload CMG shares at higher prices, the market took notice, and McDonald’s stock is up over 50% in the past year.

It looks like the market may be starting to take notice early of the EMC discrepancy, as the stock is up Monday on upgrades by Citigroup and Bear Stearns. I recommend buying EMC right now before the rest of Wall Street catches on.

Disclosure: SmartGuyAB is long EMC.

Comments

[Dennis Byron:]

You would think EMC's market cap would have started reacting as soon as it announced the VMware IPO "spinout" in February, never mind after the actual VMW launch. That's what the theory says. But there are other theories that say something like markets look ahead and markets reflect the cumulative wisdom of the buyers and sellers.

EMC is lanuguishing because those in the know know "virtualization" is a buzzword du jour, today's "dot.com." At an Infoworld conference in NYC yesterday, Stephen Hilton, an IT guy at Credit Suisse (which is doing a big server virtualization project) was asked if virtualization would take over the world in five years. He said the word virtulization "would drop out of the vocabulary in three years." I understood his point to be that this was nothing new and just the way IT infrastructure needs to be built. IBM has had it for 40-50 years on mainframes; it was only a matter of time for it to be used on PCs. It will be built into every type of software.

And the buzz about desktop and application virtualization is equally absurd. We EMC shareholders were screwed because we did not get a piece of VMW right away that we could unload during this "virtualization bubble."

2007 Sep 25 08:35 AM