EMC Corporation: Undervalued and Ripe for Buyout

Is EMC (EMC) undervalued? Can that value be maximized through a private equity transaction? I believe so.

EMC stock is not a typical stock as it has much more than an operating business under its umbrella. It also has 86% ownership of VMware (VMW) on its books. The low valuation of EMC stems from the opportunity of maximizing value of VMware ownership through creative financial structuring, and alongside a possibility that the sum of the parts in its operating business may be greater than the whole.

Let’s look at some numbers to be more specific. What is the value of EMC today (assuming market cap is approx equal to value)? Some back of the hand calculation provided below suggests that EMC's market cap is ~*$33.6B. EMC value comprises of two components, firstly, 86% of the VMware stock and secondly, the core business of EMC that includes storage, security, and content management; let’s look at the individual components. The first component, i.e. the VMware stock on EMC books, is worth close to **$20.5B. Therefore, the second component, i.e. value of core EMC's business, should be about ***$13.1B. Under this scenario, the core business of EMC trades at ~7.7X 2009 P/E [assuming expected NI of $1.7B in 2009]

Again, why is the stock undervalued and ripe for a buyout? First, the core business of EMC trades below 8x P/E, which would be considered on the low side for a large and fair growth business. A conservative metric should be close to 12 P/E. Moreover, there is an opportunity to maximize EMC core value by hiving off some of underperforming businesses and focusing on aggressively scaling core businesses. Second, and perhaps more importantly, there is an opportunity to create a transaction through which EMC can off-load VMware not only on a tax free basis, but also without impacting the share price of VMware significantly. An example of a transaction that capitalized on tax-free sale of equity on books was the take private of Seagate (by off-loading Veritas equity).

I’d very much welcome your views on valuation of EMC, and more specifically:

1. Is the value of core EMC business more than ~8X P/E? Is the sum of the parts greater than the whole?
2. Can a deal be structured in a way that EMC can unlock potential value of VMware stock on a tax free basis AND without impacting the stock price of VMware?

Notes:

• *Assuming ~Share Price = $16, ~No of Shares outstanding = 2.1B, ~Market Cap = $33.6B
• **Approximate % of Vmware owned by EMC = 86%, ~Vmware stock price = $60 ~ Number of Vmware shares outstanding = 398M, ~ Value of Vmware on EMC books = $20.5B
• ***~EMC Market Cap = $33.6B, ~Vmware Value for 86% ownership = $20.5B, ~Value of Core EMC business = $33.6B - $20.5B = $13.1B

Disclosure: Author holds a long position in EMC

Comments

[donzoab]

Weak math and analysis. First, with the current credit markets today, who is going to come up with this kind of leverage to buy emc??
Second, VMW is wildly overvalued. They are trading at full value in 2011 prices. Bring VMW down to $25/share and you will have some value to purchase here.

[skwestorange]

I agree with donzoab. VMW is indeed way overvalued. I am sure it is a question of when not if it will be priced at $25 or even less.

[Phreakonomist]

Why does every SOTP valuation assume that VMWare is correctly valued? It would be safer to assume that VMWare is outrageously overvalued based on unrealistically long high growth assumptions and EMC is reasonably valued. That being said, I am still long EMC with an eye towards hardware and kernel level virtualization technologies.

[take a guess]

For those who really think VMW is overvalued, they can short VMW and long $(1/0.86) EMC for each dollar shorted to get the 13.1B valuation on the rest of EMC. I don't know how many are already doing this right now, thus VMW may actually be still discounted because of this.

Anyway, the number published here is indeed valid. Does the rest of EMC worth 13.1B? I don't know. At least it has tons of cash and its revenue and profit has been kept growing consistently after the .com bust. (Disclosure: owns both VMW and EMC stocks)

[Puneet Gupta]

Vmware pricing is a good point and certainly the biggest risk factor that should be factored into the analysis. Perhaps vmware valuation is all the more reason that EMC shareholders should reduce their position now...

The second point on credit markets is a generalization - crappy and aggressive deals are struggling but you can always find money for a good deal.

[mhaas]

I agree with the other comment. VMW trades at a PE of 103, and has short interest of 35%. Investors think that it's overvalued, clearly. You can't just subtract the market cap of VMW, because clearly, it could not be sold at that price. Not too many private equity would like to pay 100x earnings.