EMC (EMC) provides hardware, software, and services for enterprise network storage. It has an 80% ownership stake in VMware (VMW). About 75% of EMC's revenue rests on its storage capacity, and its VMware service arm accounts for 17%.
EMC was the first company to utilize solid state drives in enterprise server arrays, and has more knowledge in this deployment than its competition. It is currently positioning itself to take advantage of falling costs on solid state drives to make reliable networked storage with less downtime more widely available to its client base. However, EMC also runs arrays based on standard processors, which use fewer resources at a lower cost and can be managed more easily by less sophisticated clients.
In addition to competing with its server pools, EMC is also working on expanding its networked storage. It added social networking and application development to its product roster with its recent acquisition of Pivotal Labs, a private software development firm, in an all-cash deal for which terms were not disclosed. I think Pivotal adds existing value as well as additional long-term growth prospects to EMC. Pivotal's project management software, Pivotal Tracker, is already being used by hundreds of thousands of developers worldwide, including developers at Twitter and Salesforce.com. Pivotal Tracker can work with EMC-developed Greenplum to aggregate and work through massive datasets in a collaborative environment, adding value to EMC's already developed hardware capabilities. As unified networking works its way into the corporate lexicon, this move positions EMC to take advantage of the three big tech trends in 2012: cloud computing, virtualization, and collaborative computing.
Pulling Profit from the Cloud
Of the big trends, I believe that cloud computing is going to be the most remunerative for companies participating in this space, particularly EMC where it will also be a major growth driver. Looking at the cloud computing space, EMC's major competitors include Hewlett-Packard (HPQ), IBM (IBM), Dell (DELL) and Cisco (CSCO). In terms of market share, these four tech heavyweights hold greater slices than EMC in cloud computing equipment. Hewlett-Packard holds 17.4%, IBM 16%, Cisco 12%, Dell 9% and EMC 6%. However, in terms of overall company size, this is an impressive performance for EMC, which by almost any measure is dwarfed by its three biggest competitors: Hewlett-Packard's market cap is $48.3 billion, IBM's market cap is $237.1 billion, and Cisco's market cap is $106.3 billion. By comparison, EMC has a market cap of $59.1 billion including its stake in VMware. Without VMware, its market cap slides to $20 billion.
I say cloud computing will be a profit-maker for EMC for several reasons. First, like most computing architectures, cloud computing margins benefit from economies of scale. Projections for Amazon Web Services, one of the first major companies to openly discuss cloud hosting as a business model, see gross margins climbing to better than 50% over the next few years. Second, the further proliferation of mobile devices, tablets, netbooks and other devices is increasing demand on cloud computing services.
What's notable, and sometimes overlooked, is that this demand is growing in the business world both through mobile and through outsourced home-office server management. Increasing technology use by companies of all sizes and deeper scrutiny of disaster recovery services mean increased demand on large volume data centers. Compared to this, personal computing is a small part of the potential profits. Lastly, despite its relatively small size EMC currently holds 25% of the networked storage market, and as its recent acquisition moves show it is looking to add value to its current offerings to capture an even larger share.
EMC is pushing cloud computing heavily with its new VSPEX Proven Infrastructure, which uses technology from alliances with Cisco, Intel, Microsoft, and VMWare. VSPEX allows multiple configurations for quicker deployment, and speaks to the "personalize everything" movement at a lower cost with a high level of mix and match servicing across severs, networks, and virtual providers. This appeal to a larger client base should increase revenues and drive the stock price higher, with the potential for effects to be seen by year-end.
Dividend and Future Outlook
If there is one thing not to like about this stock, it's that EMC does not pay a dividend. In fact, since EMC was first listed on the NYSE in 1986 it has never paid a dividend. However, among so-called dividend sinners in the tech sector EMC finds itself in good company with Dell, Yahoo, and Adobe Systems taking a similar tack. This may change as Apple's recent announcement that it will begin paying a quarterly dividend nearing 2% beginning in July is putting pressure on other tech stocks to follow suit.
EMC has almost no long term debt and $4.4 billion of free cash flow. It also has a three year average annual growth of 10%, giving stockholders healthy earnings per share growth of 21.7% over the same period. Stockholder returns would be healthier with even a nominal dividend, and clearly EMC could well afford one. I think it would be surprising if EMC did not institute at least a one-time payout by the end of the calendar year to appease growing stockholder calls for dividends from healthy tech players.
EMC is currently trading around $29. On April 9, Stifel Nicolaus raised its price target on EMC from $33 to $36. On April 12, Sterne Agee analysts, who tend to be conservative, followed suit, raising Sterne Agee's price target on EMC to $32. I believe that the truth is somewhere in between these numbers, and would put a price target for EMC at $34.
EMC's long-term growth prospects look good for the reasons that I outlined above, but a significant proportion of its revenue derives from its ownership stake in VMware, which I believe is significantly overvalued and does not have the growth potential its numbers might lead one to believe. VMware is trading at an astronomical forward price to earnings of 35.8 at its current price around $110. By comparison, EMC has a forward P/E of 14.3. I think that it's cheaper to buy EMC and own VMware by proxy through EMC's ownership stake. In my opinion, EMC represents a solid value with or without a dividend, and its proven ability to compete with the large cap tech giants reinforces its potential on a forward-looking basis. EMC will announce first quarter 2012 results on April 19.