An Opportunistic Look at EMC & VMWare

When I last looked at VMWare’s (VMW) IPO performance in August 2007 (it first IPO’d at $26 and closed at $58/share), I noted there was no disappointment. Well, until recently, that was a subtle understatement. EMC’s (EMC) spinoff hit a high of $125/share in October, only to be let down due to the general tech selloff last week. In short, VMWare’s market cap ballooned to almost 4.8 times its initial IPO market worth.

Much was due to the explosion of interest in virtualization taking hold of the IT infrastructure world, burdened heavily with physical servers and looking for release. But come earnings time, the numbers had to back up the expectations. And with an 86% stake in VMWare as its spinoff, EMC laughed its way to the bank.

EMC posted Q3 consolidated revenues of $3.3 billion, up 17% from Q3 last year. Net income increased to $429.3 million, a 77% increase (partly from a partial sale of VMWare ownership to Intel (INTC)). When drilling down into the business segments the earnings parse out as such:

Total revenues for Information Storage Business Q3 were $2.6 billion, up 8% over Q3 last year.

The content management and archiving software business revenues were $189 million, up 27% over last year.

The RSA information security business revenues were $133 million, up 22% on a comparable basis over Q3 last year.

In its earnings call, EMC reiterated that the company was on track to exceed January estimates of $12.7 billion of revenue. With the same confidence, EMC doubled its share buyback plan to $2 billion.

VMWare itself posted net earnings of $85 million and gross revenue of $357.8 million, doubling its previous figure and far higher than the analyst estimate of $334 million. Despite the stellar performance, VMWare was mum on future guidance. However, large companies and government agencies have been putting a check on buying physical servers and implementing VMWare in their systems (think of the visual of an empty white room and one server in the IBM (IBM) commercial). So as I noted in August: VMware totally dominates the rapidly emerging server virtualization market, demand is high, and the value is obvious: install VMWare, reduce hardware expenses.

Analysts missed the EMC view at first, pricing EMC as missing revenue in its core functions, but based on the earnings report it reversed as it picked up on supply companies receiving favorable orders from EMC for Q4. However, the general expectation of a weak economy in 2008, the turmoil of the financial market, and Dell (DELL) acquiring EqualLogic (a competing virtualization provider) viewed as posing a long-term threat continue to persist. The competition threat so far has been overblown; Microsoft (MSFT) posed the same concern early on, and its software version ended being a non-event to VMWare’s momentum. Additionally, EMC historically posts a weak Q1 due to seasonality, and that is a well-understood fact.

How did the market react? It eventually increased EMC to a high of almost $26/share before the November tech fallout brought it back down to earth, a pretty good increase considering the stock was under $13/share in January 2007. As for VMWare, its stock hit the ceiling at $125/share before suffering the same fate of November’s selloff. However, it still floats in the low $90s as of this article with high expectations of being dubbed “the next Google (GOOG).”

EMC, with a market cap of $49.33 billion, continues to be a bargain approach to ownership of VMWare, especially this week with a price drop under $20/share. The valuation gap between the two companies still obviously exists ($92 versus $20), and although VMWare has dropped a bit that disconnect will likely continue for the forseeable future. VMWare will still have the higher price due to expectations of its growth and a lack of real competition in the virtualization market.

So you continue to have a choice on how to get on the virtualization gravy train: buy the Lexus in VMWare if you can afford it on a bargain day, or get the same value in the Toyota pickup truck of EMC. Both are offered by the same company in essence. And the current market volatility is actually a great time to be opportunistic in buying either or both at a relatively attractive price.

Comments

[User 123329:]

the comments taken from your article (copied below) clearly show you have no clue what you are talking about... a stock's trading price has absolutely nothing to do with the value of the underlying company.. a stock at 92 isn't "worth more" than a stock at 20 necessarily, you can't tell from the share price alone...you should really learn that

The valuation gap between the two companies still obviously exists ($92 versus $20), and although VMWare has dropped a bit that disconnect will likely continue for the forseeable future. VMWare will still have the higher price due to expectations of its growth and a lack of real competition in the virtualization market.

2007 Nov 16 04:32 PM

[js202:]

"a stock's trading price has absolutely nothing to do with the value of the underlying company..."

What on earth are you talking about? Tell this to an economist and he or she will laugh until they are blue in the face... I'm asuming you meant "a stock's trading price doesn't necessarily correlate with the value of the underlying company..."

2007 Nov 16 05:30 PM

[js202:]

"a stock's trading price has absolutely nothing to do with the value of the underlying company..."

What on earth are you talking about? Tell this to an economist and he or she will laugh until they are blue in the face... I'm asuming you meant "a stock's trading price doesn't necessarily correlate with the value of the underlying company..."

2007 Nov 16 05:30 PM

[Ginsu2000:]

Equilogic is not a competitor to VMware - they offer Storage Area Network (SAN) solutions for ethernet, something that EMC also provides. Equilogic is not significant, and these stocks VMW and EMC are both severely undervalued. The same thing occured to Garmin and is attributed to bidding or not bidding on Teleatlas a mapping provider... the reality is Garmin, like VMWare is the market leader and driving innovation across several sectors - engineers workbench and the datacentre in the case of VMWare and the aviation, marine and automotive industries in the case of Garmin. The leadership and growth in these industries, and the foothold they both have through clever marketting in particular rental car companies adopting Garmin GPS for hire, and EMC ownership of distribution channels mean, as well as massive demand mean these stocks should sail forward. The reality is that people are jittery about the US economy but as both of these companies produce global products, I fail to see the relevance, or why these stocks fell. Perhaps misinformed by comments such as Oracle or Equilogic offering anything that comes remotely close to competing with VMWare in the core business of OS virtualisation!

Full disclosure: I am a R&D software engineer and pilot who uses these products and follow both of these stocks and am long EMC and GRMN.

2007 Dec 02 08:11 AM