Buying Opportunity with VMware

VMware (VMW) is facing troubled times. With the recent announcement of Microsoft (MSFT) entering the hypervisor (virtual machine monitor) business, the management change of CEO Diane Greene being fired and management having to revise down guidance, the stock has hit quite a turbulent patch.

Tuesday's Q2 results took the stock to a new 52-week low of $34.17. Compare this to October of last year when it hit a high of $125 and was dubbed the “next Google. (GOOG).”

Q2 revenues of $456 million missed the market’s expectations of $459 million and recorded annual growth of 54% and sequential growth of 4%.

U.S. revenues grew 43% over the year to $240 million, contributing 53% of overall revenues. International revenues grew 68% over the year, and the company continued to experience good traction in the emerging markets of India, China, Latin America and Eastern Europe.

License revenue contributed $284 million to the quarter, registering annual growth of 39%. Sequentially, revenues from this segment dropped 3%. Support maintenance and professional services revenue grew 85% over the year and 19% over the quarter to $172 million.

EPS of $0.23 met the market’s expectations and grew by $0.01 over the quarter.

Management is expecting revenue growth of 42%-45% after having reaffirmed growth of 50% in the previous quarter’s announcements.

With cloud computing gaining momentum, there is a growing need to applying existing infrastructure and techniques to deliver a more effective desktop management. VMware has been focusing its efforts on these technologies, in order to be able to cater to these opportunities. Its VMware Infrastructure Technology has helped build and operate clouds and allowed “existing customers to migrate their existing computing loads very flexibly out of the environments into the cloud and back.”

Revenue concerns were driven by the company’s perception of performance in the Enterprise License Agreements space. ELA contribute around 20% of VMW’s quarterly bookings and are key to long-term relationships with customers.

With tougher economic conditions, purchases are subject to a longer sales cycle, especially in the U.S. Further, customers are also willing to forego discounts available with buying for longer-term deployment and are purchasing products for their short-term needs. Add to that the presence of Microsoft, and VMW realizes that even though the company might not lose its market leadership, competition will definitely become tough.

Meanwhile, VMW continued with its product innovations, and its VMware Infrastructure suite is already in its third release. This product enables centralized management load balancing, live migration and disaster recovery. VMW has started developing its fourth generation suite, which is due for release next year. The company realizes the growth potential offered by the SMEs and have already taken steps to introduce lower-priced SKUs for our VMware Infrastructure.

However, the looming question is still the one that Diane Greene was asking: Should EMC Corp. (EMC) spin VMware out entirely? Why does the EMC CEO have the right to fire Diane Greene? He has the right because EMC is VMware’s single largest shareholder, and In effect, VMware still has to operate as a division of EMC, to which Greene had objected. Joseph Tucci, the EMC CEO, has promised to do the right thing by shareholders. Well, we are waiting to see what that is.

In many ways, this is a perfect opportunity to buy VMware. The company needs sustained execution, which I would imagine an experienced executive like Paul Maritz should be able to deliver, albeit perhaps without the passion of its founder. On the positive side, Maritz is an EMC executive, and will also operate without the friction and animosity that brewed between Greene and Tucci. He can focus on the business, not the politics. I like that.

Disclosure: None

Comments

[Santosh Sankar:]

I agree with you, this is a great time to scoop up a solid share of VMWare. The company may face some rough patches in the short run but a solid long term holding with the terrific products it offers.

2008 Jul 24 09:01 AM

[MakeMoneyWi...:]

I respectfully disagree. I think there is more downside to VMW based on increased competition from Microsoft and Citrix. However, the company has solid products and needs to review its strategy. May become a good buy in mid 20s within the next 2 months or so.

2008 Jul 24 08:33 PM

[Santosh Sankar:]

MSFT and CTXS are solid competitors, but I believe this pressure will have management rethink strategy and fight back. If you compare the product offerings, VMWare provides excellent solutions and often times MSFTs products take a few versions to get the kinks out. Companies do not want to deal with this when investing in expensive tech, this is where the quality and experience VMW has will trump the competition.

2008 Jul 25 09:39 PM

[johnnysize:]

I quick JV announcement and this thing rallies...shorts are squeezed, and it fills the gap to 50.

2008 Aug 07 09:43 AM

[Francorp:]

VMW will make a come back, this market is growing and this company is positioned to take advantage of it. The stock may take some time to get back to its 125 levels, but it should perform well with a new sales approach.

2008 Aug 28 10:03 AM