EMC Price Targets Too Low; Seize This Opportunity

At the end of the last decade and in early 2000 (just before the tech stocks meltdown), the euphoria and confidence in setting price targets on technology stocks was amazing. The parade of the "brilliant" analysts trying to outbid each other in setting a higher target for a stock had become absolutely ludicrous. Eventaully, it became a self-fulfilling prophecy. Within a short time, the bottom fell out and then looking at the earlier price targets, one could only ask "What were they smoking?".

Now in 2007, more than 7 years after those ill-fated calls, many of the analysts seem to be still carrying the memories of their misplaced bullishness. This is especially true in the price targets being set for EMC Corporation (EMC). The targets are too low.

In a nutshell, EMC makes network storage devices. This is a solid business with good long term growth prospects as needs for data storage are going to increase. EMC bought virtualization software maker VMWare (VMW) a few years ago. Virtualization have come of age, EMC spun off VMWare through an IPO in August this year. After the spinoff EMC still retains an 86% stake in VMWare.

VMWare's valuation today is around $46B. This makes EMC's 86% stake worth about $39.5B.

Earnings estimates for EMC for 2008 range from $0.75 to $0.96. Lets take the safest approach and assume core EMC earnings of $0.75 for 2008. (excluding earnings from VMWare). At a modest 20 price-to-earnings ratio of this gives us a stock price of $15 for core EMC business.

Now if we add today's value of its VMWare stake ($39.5B) which is worth about $19/share, we get a EMC stock price of $15 + $19 = $34. This is based on VMWare stock price yesterday and does not even account for any further gains in the same.

Most of the price targets on EMC today are in the high 20s or low 30s. From the above back of the envelope calculation it is obvious that, that is a gross undervaluation of a solid company.

VMWare makes virtualization software which enables computer servers to run multiple "virtual machines" on the same computer. This is a paradigm shift in the way IT infrastructure is going to be managed. Over the past few decades, whoever has forseen the paradigm shifts in technology and stayed ahead of the curve has come out winning e.g. Microsoft (operating system for every desktop), Google (entry to the internet combined with advertising), etc. VMWare's technology is at a similar stage right now. Eventually, it will become ubiquitous on all IT infrastructure servers. Which means there is a very large market that has been not tapped at all.

I feel that most of the analysts have set the price targets on EMC too low. As VMWare stock price soars, EMC's stock is going to track VMWare stock price changes more and more closely, leading to large gains. If you have a 3 - 5 year investing horizon, then I suggest picking up shares of EMC on any pullbacks, sit back and enjoy one hell of a ride.

Disclosure: Author is long on EMC stock and also owns EMC $25 JAN 2010 CALLs.

Comments

[John Lazerow:]

The discount that the "analysts" get to relative to your target price is based on the notion that VM Ware is probably overvalued here because of too little supply of stock and way too much demand. Only 46 million shares float out of 382 million. I agree, though, that the stock looks cheap in here even if you discount the VM Ware stake by 20%.

2007 Oct 30 09:49 AM

[anonymouse:]

Please check your assumptions. I think EMC's earnings include VMware's.

On www.emc.com/ir/faq/vmw... they say "VMware’s income statement and balance sheet will continue to be consolidated into EMC’s with entries to reflect the minority proportion of VMware not owned by EMC."

2007 Oct 31 11:27 AM

[Manoj:]

www.emc.com/ir/investo...

From the EMC Q3 2007 Earnings Webcast presentation:

EPS excluding VMW contribution and excluding one time gain on sale of VMW stock to Cisco is $0.15. VMWare contributed an <b>additional<... $0.026 per share.

If you see slide 13 of 22, the change in EPS for the Infrastructure (i.e. excluding VMW) is about 18% YoY.

YTD07 EMC Infrastructure EPS is $0.53. Add another $0.15 for Q42007 and you get $0.68 for 2007 EPS.

Assuming a 18% YOY growth, 2008 Infrastructure EPS should be about $0.68*1.18 = $0.80.

I have assumed $0.75.

2007 Oct 31 05:08 PM

[anonymouse:]

Thank you for posting that. I will take a more careful look. And I was considering selling!

2007 Nov 01 01:33 PM

[stock investor:]

VMW (current: $116) stock is only $30 away from overtaking EMCs market-cap. At current growth rate, this should happen by January 2008 and then EMC + VMW are going to be in sync. I am buying some option calls for 2009, adios~

2007 Nov 02 04:08 PM