EMC: A Great Way To Profit From VMWare

Includes: DVMT, VMW
by: Smart Guy Stocks

Lately, it seems that you can’t go a day without reading another article touting the success and potential of VMWare (NYSE:VMW), the recently IPO-ed software virtualization company. VMW has skyrocketed from its August IPO price of $29 to its current perch at $84. Although the growth prospects of VMWare are tremendous, it’s not the type of stock I feel comfortable trading- its forward PE of 93 and a 30+ P/S don’t leave much room for error.

However, the recent run-up in price and continued positive momentum (4 new analysts came out with “Buy” ratings on the stock Monday) have created a less risky way to play the stock, one that also capitalizes on an apparent market inefficiency. VMWare was spun-off from EMC (EMC), the computer software and infrastructure giant. EMC retains 87% ownership in VMWare, a stake currently worth about $28B.

That means you can purchase the rest of EMC for less than $14B, a bargain for a leading technology company with a couple billion in net cash and $12.9B in expected 2007 revenue. And EMC gives you another way to play the success of VMWare and virtualization- the company makes a suite of products designed for optimization of VMWare environments.

Oddly, although the value of EMC’s stake in VMWare has risen nearly $19B since the IPO, the market cap of EMC has risen only $3B. Yet there haven’t been any other public negative catalysts that could account for EMC’s depressed share price. A similar phenomenon marked the McDonald’s (NYSE:MCD)-Chipotle (NYSE:CMG) IPO. Although CMG soared, shares of McDonald’s, which owned a controlling interest, languished for months. Eventually, as McDonald’s continued to unload CMG shares at higher prices, the market took notice, and McDonald’s stock is up over 50% in the past year.

It looks like the market may be starting to take notice early of the EMC discrepancy, as the stock is up Monday on upgrades by Citigroup and Bear Stearns. I recommend buying EMC right now before the rest of Wall Street catches on.

Disclosure: SmartGuyAB is long EMC.