EMC and VMware, Once Threatened by Cloud Computing, Thriving Up There

Five years ago when investors first began hearing about cloud computing, it looked like a big threat to EMC Corp. (EMC) and its 79%-owned, publicly-traded, software unit, VMware Corp. (VMW).

But now, it looks increasingly clear that the two companies have navigated the early days of the transition to the cloud, and that they are well positioned to continue to thrive. The stock prices of the two companies tend to move in lock-step, which makes sense since the stake in VMware currently accounts for 55% of EMC’s market cap.

EMC Chart

EMC data by YCharts

The two companies are currently involved in a complex management pas-de-deux. EMC’s chief operating officer, Pat Gelsinger, this week moved to become chief executive officer at VMware. Paul Maritz, a former Microsoft and EMC executive who has been CEO at VMware since 2008, returned to EMC.

Maritz will be chief strategist for EMC, assisting chairman and CEO Joseph Tucci. Tucci turned 65 this year and announced he was delaying his planned December retirement. But outsiders note that the 57-year old Maritz is well positioned to become CEO of EMC.

By most measures, Maritz and Tucci both get good marks for their companies’ performance this year. While most big tech firms have suffered in the worldwide slowdown, VMware revenue grew 24% and EMC’s rose 6.6% over the last 12 months.

EMC Revenue Chart

EMC Revenue data by YCharts

Nevertheless, this year, VMware trails all the other big software companies for stock price growth, reflecting a sharp slowdown in its earning growth rate.

VMW Chart

VMW data by YCharts

VMware, with a trailing PE ratio of 51, is highly sensitive to any slowdown in its earnings growth. Reflecting the value of VMware, EMC’s PE ratio is 22, a nosebleed level compared to most enterprise hardware companies.

VMW PE Ratio Chart

VMW PE Ratio data by YCharts

It seems increasingly clear that VMware and EMC are well positioned to benefit from the technology transition to cloud computing. In fact, it could be argued that VMware, in particular is driving the technology forward.

Cloud computing involves moving computing tasks to large, hosted data centers where companies like Amazon (AMZN) and RackSpace (RAX) take care of operating the computers and software and cut costs by sharing the infrastructure among many customers.

Those cloud operators tend to view computer storage (such as EMC makes) and data center software (such as VMware provides) as commodities, and they are big enough to build their own or buy it at bargain-basement prices.

The technology threatened data storage giant EMC because it meant that more and more companies would be storing their data in cloud-computing facilities rather than inside their own data centers. EMC’s advanced technology and legendary direct-sales force had long held sway with corporate CIOs.

It threatened VMware because companies shrinking their own data centers needed less of VMware’s virtualization software. Ironically, VMware itself enabled the whole cloud-computing model by figuring out a way to write software that created multiple software servers running on each Intel hardware server. That was attractive for companies that quickly discovered they could control the growth of their own data centers. But it was only a small step beyond for cloud hosts to develop ways to virtualize servers for many different companies in much larger and more economical cloud data centers.

But data centers haven’t disappeared. Most big companies still operate their own data centers for core operations. They worry about security of tightly regulated data like health information if it ends up in public clouds. Many are developing hybrid strategies with some functions, like e-mail and application development, in public clouds, and many applications still running on virtual servers in their own data centers.

VMware has also cemented its dominance of the virtualization market. Gartner estimates that a whopping 80% of virtualized workloads run on VMware, despite competition from Microsoft and open-source projects.

VMware under Maritz has spent the last three years building and buying technology to create a virtualized data center. Its recent acquisition of Nicira gives it a big foothold in the potentially massive virtual networking market. It estimates that it can now address a $50 billion annual market, up from just $20 billion a year ago.

Meanwhile, VMware recently reiterated that it continues to expect 18% to 22% revenue growth in the current year to over $4.5 billion.

EMC, too, is well positioned to grow due to continued huge increases in the amount of data being stored. This year, despite the global IT spending slowdown, it anticipates full year revenue of $22 billion, up 10% from 2011.

Bill Bulkeley is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.



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