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Buying Opportunity with VMWare

Posted on Wednesday, Jul 23rd 2008

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

Yesterday’s Q2 results took the stock to a new 52-week low of $34.17. Compare this with when it hit a high of $125 in October of last year and was dubbed the “next Google”.

1yr VMW

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

US 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 one cent over the quarter.

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

With cloud computing gaining momentum, there is a growing need to applying existing infrastructure and techniques to deliver much more effective desktop management. VMware has been focusing its efforts on these technologies and will be able to cater to these opportunities. Their VMware Infrastructure Technology has helped build and operate clouds and also 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 US. 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 they might not lose out on their market leadership, competition will definitely become tough.

Meanwhile, VMW continued with its product innovations, and their 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 their fourth generation suite, which is due for release next year. They realize the growth potential offered by the SMEs and have already taken steps to introduce lower-priced SKUs for our VMware Infrastructure.

But the looming question is still the one that Diane Greene was asking … should EMC spin VMWare out entirely? Why does the EMC CEO have the right to fire Diane Greene? Because, EMC is VMWare’s single largest shareholder. 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 operate, also, without the friction and animosity that brewed between Greene and Tucci. He can focus on the business, not the politics. I like that.

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The potential from emergent markets in India, China and South America is undeniable particularly with the forthcoming oil boom in Brazil and the technical conversion of Venezuela.

This would appear to be the future evolution to virtual storage and computing however it will need to be reliable after the Amazon burn out at the weekend and eco considerations will need to be part of strategy with an increased focus now on data centre energy consumption.

The next generation of processors will facilitate all the speed needed, and the market potential is undeniable.

David Bristow Wednesday, July 23, 2008 at 1:38 PM PT

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