Notes on VMWare's Special Shareholder Meeting

I have been so busy, I thought yesterday was VMware's (VMW) annual shareholder meeting. I picked up my materials and ran off to the 8AM meeting in Palo Alto, only to realize my mistake. VMware was only holding a special meeting to vote on whether to approve a one-time stock option plan. Basically, the company's stock price has gone down significantly, causing most of its employees' options to be underwater. My understanding is the meeting yesterday was held because VMware wanted to replace the existing stock options with newer ones.

The CEO, Mark Peek, gave a short presentation, and the the stock option plan was approved after confirming a quorum. Mr. Peek seems like an honest, smart CEO. He has a British accent, and took questions from the few shareholders present (four of us), even though the format of the special meeting didn't require him to do so. The meeting lasted only 20 minutes, and only coffee was served.

I asked about the tax consequences of the stock option plan. The CFO answered that because the options had not been exercised, there was "no significant impact" tax-wise. Once the employees exercised their new stock options, the company would be able to record a tax deduction, which would actually benefit the company (but of course, dilute existing shareholders).

I asked a question about what the company does. I am not a born techie, so the concept of virtualization and virtual machines is strange to me. (Every time I hear the term, "virtual machines," I think of the Borg and T2's "Rise of the Machines.") Peter Lynch's advice, "Invest in what you know," worked well in the past, but these days, it's hard to follow that simple rule.

The CEO Peek very politely attempted to answer my question about the company's products. He said the company is a software company involved in "virtualization." VMware software "fools" other software/hardware platforms, allowing greater functionality. Previously, users had to have different machines to run different operating systems, but now they could use just one machine. For example, we can use Windows and Apple's Leopard on the same computer with VMware's software. CEO Peek went further, saying VMware is a "data management/IT company." It manages the computer environment, and the company had "700 third party customers."

Another shareholder mentioned Larry Ellison and how he had grown Oracle by not selling his software outright, but requiring users to subscribe to it. CEO Peek indicated VMware has different pricing plans, just like Oracle (ORCL).

Overall, I left the meeting feeling like I was in the presence of professional, dedicated people. I still don't know what virtual machines are, or how they really work, or how a company can monetize such an asset, but perhaps I will ask more questions at the annual meeting next year.

One interesting item in the special meeting report: beneficial shareholders of VMware include Intel Corporation (INTC) (18.30%); and Cisco Systems International (CSCO) (6.88%). As mentioned above, due to having greater voting rights, WMware is basically owned by EMC Corporation (EMC), which holds 97.17% of the Class B shares and "98% of the voting power of outstanding common stock" (page 48, Form 10-Q).

Another interesting item: VMware gives its partners access to its source code and hypervisor for development purposes, which may create IP issues later on.

The end result of yesterday's meeting for me? I picked up more shares of EMC afterwards. I figure it's a safer bet to invest in the quasi-parent company than in the newer company (e.g., buy Cypress Semiconductor (CY) rather than Sunpower (SPWR)) , especially because spinoffs usually saddle the newer company with debt. I am concerned about the market's volatility, but now seems like a good time to slowly add to positions.

Disclosure: Long EMC

Comments

[weiwentg:]

With all due respect, why did you buy VMWare without knowing what it does?

And who were the main beneficiaries of the company's reset of its options strike price? Were employees the main beneficiaries, or was this just a giveaway to management?

2008 Sep 10 07:47 AM

[reyito:]

Are you high? Mark Peek is the CFO and I agree with Weiwentg, why buy the stock if you don't know what the company does? Thanks for breaking the news on Intel and Cisco. Go back to sleep....

2008 Sep 10 10:05 AM

[Matthew Rafat:]

You are correct about Maritz, not Peek, being the CEO. The nametags were small, and I didn't get a good view of the speaker's handwritten name. As for who the main beneficiaries were of the company's stock option reset, my understanding is that the benefits were spread to everyone, not just management. The 10-Q has more information. In the future, when a company has a stock option reset, I will ask about the primary beneficiaries.

What's interesting about Intel owning so many VMware shares is its access to VMware's source code. Intel has recently stated it wants to compete in the same area as VMware.

2008 Sep 10 01:17 PM

[RTFM:]

I hope you don't intend to waste people's times at the annual stockholder meeting with such stupid questions. You're so clueless about the company you have no business covering it. I do admire your guts to publically humiliate yourself like this.

2008 Sep 10 09:25 PM

[Matthew Rafat:]

RTFM: explain what "virtualization" is. The CEO didn't do a thorough job, which is the reason my posting here is sparse on details. I have a generalized idea that "virtualization" can result in one machine consolidating functions and backup usually performed by multiple machines. From a storage perspective, this sounds intriguing, but I don't see how VMWare has a "wide moat" or how it can prevent its technology from becoming a commodity, like memory backup (i.e., review what happened to Iomega). I look forward to your detailed post with details on how VMWare can make money on "virtualization" and what prevents competitors from creating their own "virtualization" products to compete directly with VMWare.

2008 Sep 10 09:55 PM

[RTFM:]

The word "virtualization" itself is a term that has largely meaningless because it means so many different things to so many people (other examples include "multimedia", "technology", and "cloud computing"). For details on "virtual machines" (the VM in VMware), the VMware homepage has a link to "get an intro to virtualization", but the one-phrase summary is that virtual machine technology lets you run virtual computers within your computer. Common motivations are to run different types of software apps or OSes, or consolidate multiple physical machines into one.

The "hypervisor" is the component that is getting commoditized, in part due to features being added to processors (which make it easier to write a hypervisor that works, but not necessary a good one). As with any software industry, it's a matter of establishing a lead over competitors and working to maintain that lead as they catchup to certain advantages. The lead is often defined in terms of features, but in this area also applies to performance, stability, correctness, ecosystem of complementing products, etc.

A competitor like Microsoft will only care to have their VM product run on their OS (i.e., Windows), and focus on making sure their OS will work well in their virtual machines (while not caring so much about other OSes like Linux or Solaris). It took MSFT 5 years after acquiring Connectix to ship a competitor to VMware's high-end hypervisor, and it still lacks important features (e.g., VMware's VMotion, which lets you transition from running a VM on one physical computer to running on another physical computer with sub-second downtime of that VM). Other aspects are subtle but important. For example, being able to take a VM that was running under one version of a VM product and then upgrade to a newer version of the VM product and still be able to use that VM without losing information. VMware generally allows you to do this, while MSFT has not so far (even between the RC and RTM versions of hyper-v). This gets to be a big deal with you have 1000s of VMs, which is also why more revenue is coming from other areas like management software than from the core hypervisor products.

In the Macintosh product space the competition is closer to VMware's heals, in part because VMware got a late start but also because the main competitor sacrificed quality and stability to get where they're at.

2008 Sep 11 05:21 AM

[Matthew Rafat:]

RTFM, you've given one of the better explanations that exist about VMware's business. Thank you. In some ways, this sounds like an arms race--perhaps VMWare's products aren't absolutely necessary for a company, but if companies do not adopt the more advanced technology, they will be left behind. I realize my knowledge is extremely limited, but I am not a techie. Thank you again for your detailed post.

2008 Sep 11 01:41 PM

[df00z:]

VmWare was basically one of the first and is currently the market leader in virtualization. In layman's terms, computers are getting more and more powerful, and VmWare's virtualization technology allows you to leverage and manage IT resources much, much better. They provide an application where you can centrally manage all your systems and view resource usage. You also save space in the data center, save power usage, and improve redundancy and uptime by virtualizing. To give an oversimplified example..

Say you have two computers at home. One is relatively busy, the other is used just to check email. Imagine being able to have multiple people on the computer at the same time and only having to need one.

Not everyone is, "on board", there are a lot of customers to be made, and this is a critical time for VmWare. We currently manage over 300 virtual servers using VmWare products.

2008 Sep 16 11:24 PM