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Amidst Volatility, Be Opportunistic with EMC & VMWare

Posted on Wednesday, Nov 14th 2007

When I last looked at VMWare’s (VMW) IPO performance in August 2007 (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 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). 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.

EMC reiterated in its earnings call 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 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 they reversed as they 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 acquiring EqualLogic (a competing virtualization provider, although they are trying to position as a VMWare partner) viewed as posing a long-term threat continue to persist. The competition threat so far has been overblown; Microsoft 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.”

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.

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Have you taken into consideration the new product from Oracle as well as other players in the virtualization arena? Couldn’t this competition keep the share price down?

Susan Friday, November 16, 2007 at 6:50 AM PT


When the overall market has so much growth, there is always room for more than one player. So the answer is, no.


Sramana Mitra Friday, November 16, 2007 at 10:07 AM PT

So what if the share price of VMware is 5 times EMC’s?

If the float were 100 shares of VMware, it wouldn’t matter if its price was 50x. The point is the relative market caps — VMW’s is 32B and EMCs is 41B, so subtracting EMCs 15B share of VMW, it’s being valued at 26B or around the $13/share of last January and a PE around 20. That doesn’t strike me as outrageously undervalued.

Tinman von Blowhard Friday, November 16, 2007 at 2:08 PM PT


EMC market cap=41
VMW market cap=32

EMC owns 86% of VMW, which is: 27 billion and not 15 billion.

that makes EMC worth around 13.5 billion, which is pretty less for a company earning 1.2 billion in income every year.

techy2468 Friday, November 16, 2007 at 2:50 PM PT

here is my plan:

buy EMC=80% of capital

protect EMC investment with short of VMW- 20% of capital (or buy puts of jan 2009, with 20%)

reason being that in this bear market VMW has more chance of falling lower, and EMC will catchup to its true valuation in the next 6-8 months.

techy2468 Friday, November 16, 2007 at 2:54 PM PT

Thanks for the correction.

I like long EMC and VMW puts, but I’d split it closer to 90/10 myself.

Tinman von Blowhard Friday, November 16, 2007 at 4:58 PM PT

I bought shares of VMW at $112, then bought it again at $93 and it finished today below $79. I wonder if I am in trouble or should I try to reduce my break even number by buying more?

Thanks, Mary

Mary Friday, November 23, 2007 at 3:43 PM PT

Hi Mary,

I tend to use Stop Loss mechanisms below a certain level of drop in stock prices. By and large, when I use them judiciously, I don’t end up losing silly amounts of money.

The way I would play VMW is buy low / sell high. This is not a long term buy and hold stock.

In fact, most stocks are probably better played in the buy on weakness / sell on strength mode.

I have tried long term buy and hold, but it hasn’t worked as well for me, even though it is Buffet’s mantra.


Sramana Mitra Friday, November 23, 2007 at 6:52 PM PT

[…] The stock had slipped to an all-time low of $18.30 late last week, but has recovered substantially since to trade at $28.22. VMW was once deemed as the next Google. […]

Strong Results From VMW, EMC - Sramana Mitra on Strategy Friday, October 31, 2008 at 8:27 AM PT