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VMWare’s IPO: Wait?

Posted on Wednesday, Aug 15th 2007

It has been a strange summer of uncertainties elsewhere in the market, but certainly, VMWare’s hot IPO has not felt any of the pressure. In fact, it has made a slow August exciting with one of Tech’s most important events this year.

Eric Savitz at Barrons reports: “EMC (EMC) today generated a massive return on its investment in VMware (VMW). EMC bought the company in 2004 for $625 million. At the time, as EMC CFO Dave Goulden noted in an interview with Tech Trader Dailythis morning, VM had come off a year when it did $75 million in revenue, and there was some criticism that EMC had overpaid. Well, apparently not. The company’s 85.6% stake is now worth in the vicinity of $16 billion.

What makes the deal so attractive is the company’s impressive growth. As Goulden notes, the company in the latest quarter was on a $1.2 billion annual run rate, and still growing close to 100%. He notes that only about 1 million servers so far are running virtualization software out of an installed base of about 25 million servers; Goulden says that “about 80% of Intel-based workloads can work well in virtualized environments.” And as both Intel and Advance Micro Devices adopt their chips to work better with virtualization software, he says, the addressable total should move even higher.

Another key factor is that competition at this point is fairly limited. Goulden points to two primary competitors: Microsoft, which plans to launch its own virtualization software sometime next year, and an open source offering called Zensource.”

If you are wondering why virtualization is important, try this. A lot of expensive hardware (mostly servers) has been bought by companies all over the world, that was originally designed to run one single Operating System. In many cases, the existing OS that is on the computer is an old one. VMWare’s virtualization software enables separating the hardware from the software, run multiple OS on a single hardware, and make it possible to upgrade and utilize hardware infrastructure at a much higher rate of efficiency. With virtualization, available hardware resources can be “seen” and “deployed” easily.

On the desktop side, Virtualization’s great benefit lies in delivering a secure computing environment. Enterprises can manage zillions of desktops from a centralized control point, and enforce security and governance policies without losing control due to individual users’ whimsical loading and removal of software, thereby introducing security holes.

The desktop value proposition is remarkably sharp, solving critical pain-points for enterprise IT departments. Security and Governance policy enforcement is one of the top 3 issues that CIOs are concerned about, putting VMWare right up there in the IT buyers’ purchase cycle. The server-side value proposition is a straight-forward Total Cost of Ownership (TCO) reduction benefit, and goes straight to the bottomline.

I think, the explanation above in Eric Savitz’ article of the server-side growth opportunity is actually less exciting than the desktop virtualization story, which is far more compelling. I peg this company more as a Security/Compliance play than a TCO play.

Regardless, this is a really solid company with infinite growth ahead. Once it is done with the large enterprises, it can go after Small Medium Enterprises (SME), and its security value proposition would still hold. The stock has soared on its opening day. It’s big shareholders EMC, Intel, and Cisco are sitting on shares worth a lot. Some analysts suggest buying those to get a position in VMWare, which personally, I don’t like as much. EMC may be, not Intel or Cisco. They’re too big and too diversified.

In general, I prefer to stick with pure plays that align with long term growth trends, and are focused companies, and boy, VMWare surely is one such. If you haven’t got in already and are largely a long term investor (not a Trader), I suggest wait, and look for a buying opportunity that is caused by some macro issue, or some faltering by the company as management learns to operate as a public company.

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There are also good possibilities in the desktop virtualization space, which literally doubles their current market I think.
If you look at it, (as examples) call centers which run desktop software (which are a pain to maintain, manage and upgrade) and BPO companies (which due to security) are looking to have a zero footprint desktop, this will be the next big opportunity for VMWare.

They will probably acquire a couple of companies to address this space, but the possibilities are great.

FD: I am long VMWare and own some shares.

Mukund Mohan Wednesday, August 15, 2007 at 11:43 AM PT

[…] Still, for investors who want to invest directly, Sramana Mitra (Sramana Mitra on Strategy) recommends waiting until this high-flyer pulls back a little […]

STOCKCLIX » VMW + EMC = $$$$ Thursday, August 16, 2007 at 9:12 AM PT

I would wait for a pull back to the $40 range. At current price, imlies company will double every year for the next five years. Rember, this is no Google and anyone can do what they do. Its not rocket science, Google Algorithms!

MpumiM, Johannesburg, SA. Friday, August 17, 2007 at 9:28 AM PT

hi nice post, i enjoyed it

Jessica Saturday, August 18, 2007 at 11:25 PM PT

Great article, love the insight into the IPO and the reality of what’s to come.

Truth be told, it could become a giant company but you have to wonder if somehow MSFT and the other big dogs will throw VMWare off track.

Time will tell.

Great analysis!

Ted Sunday, August 19, 2007 at 9:14 PM PT

[…] (EMC) Coverage: VMWare’s IPO: Wait? Needless to say, the bet is on VMW, and I found an opportunity to buy EMC at a good […]

Taking Stock - Sramana Mitra on Strategy Wednesday, October 10, 2007 at 8:07 AM PT

Own both!!!

I think EMC should spin off 10% of VMW to EMC shareholders. More liquidity for VMW, and a nice bid for EMC.

Fred Wednesday, October 10, 2007 at 11:50 AM PT