EMC Spinoff Offers Pure Play In Virtualization Market
investors.com
INVESTOR'S BUSINESS DAILY
Posted 7/16/2007
VMware Inc.
Palo Alto, Calif.
(650) 427-5000
vmware.com
Lead underwriters:
Citi, JPMorgan and Lehman Bros.
Offering price: $23-$25
Expected date: TBA
Ticker: VMW
THE BUZZ
Next to Blackstone, (BX) perhaps, VMware has been the most hotly anticipated IPO this year. The partial spinoff by EMC (EMC) of its virtualization software unit will offer investors a pure play in a booming tech field.
"The key point is that this is a very fast-growing, very dynamic market, and it's still relatively early in the game," said analyst Dan Renouard of Robert W. Baird. "And these guys have a huge lead on everybody else."
Virtualization, for those not up on the latest tech-speak, is a technology that lets one physical server act like multiple electronic servers. It uses the hardware's capacity much more efficiently than the conventional model, so users get more computing power out of the same equipment.
Only about half a million servers worldwide were virtualized as of last year, but industry researcher Gartner expects that to jump to around 4 million by 2009. VMware, as the first mover, owns over 90% of that market.
But that kind of growth has attracted some big-name competitors lately, including industry titan Microsoft. (MSFT) Matt Dyckman, a partner with corporate law firm Thacher Proffitt, says this may have something to do with the IPO's timing.
"Maybe they're thinking that now's the time to spin this off, since the market position's never going to be better," he said.
However, Renouard says the current price range, which the firm set on July 9, seems a little low.
"I think ultimately it will get priced higher," he said. "And there's room for it to trade up even from there."
As a further vote of confidence, Intel (INTC) bought a 2.5% stake in VMware last week. The purchase got a fair amount of ink, but both Renouard and Dyckman say that since Intel already is a leading VMware partner it was not a surprise to those in the industry.
THE COMPANY
VMware was founded in 1998 and shipped its first product the next year. EMC bought it in 2003.
The product range hasn't expanded much — currently, the firm offers 16 products — but the customer base certainly has. VMware says it has sold to over 20,000 organizations worldwide, including every single company in the Fortune 100.
In technical terms, VMware caters to anybody who uses an x86 server. X86 emerged 20 years ago as a cheaper alternative to Unix, and now accounts for 93% of new server shipments.
Despite its popularity, the x86 server presents certain problems. Although the upfront cost of an x86 has been falling, operating costs have been rising.
There's also a lot of unused capacity: Researcher IDC estimates that up to 90% of the average x86's capacity is idle.
VMware believes these problems arise from what it calls the "one application, one server" model. Its flagship software product, the VMware Workstation, lets a user partition his server into multiple virtual servers, each running a different application. The company says the typical user has five virtual servers per physical server, but its system supports as many as 20.
As with many software makers, VMware's offerings range from free entry-level products to high-end versions used by IT professionals.
It also sells a range of automation products that help reduce the complexity of operating its systems, and thereby the potential for error.
RISKS/CHALLENGES
VMware faces the same set of risks that any tech firm faces, especially one catering to a niche market. It must keep improving its technology, it must keep up its customer service, and it must protect its intellectual property.
The Microsoft threat is still somewhat speculative, but it's ever growing. Currently, Mr. Softy offers only some free entry-level products. But it has announced a plan to launch a more complex platform that will compete directly with VMware. Open-source firm XenSource has also gotten in on the act.
VMware depends on two distributors for around 40% of its sales, and it expects that concentration to continue for the foreseeable future. Any disruption in one of those relationships could hurt business.
EMC is only selling 10% of VMware's stock in the offering, so it will still have dominant control over the company. VMware shareholders will have little say in policy matters.
About 44% of sales come from outside the U.S. This exposes the company to a variety of political, regulatory and foreign-exchange risks.
THE RESULTS
In the first quarter, sales doubled over the prior year to $258.7 million.
Net income increased by the same amount, comprising 15.9% of sales in both quarters.
An increase in research and development expenses was offset by a lower tax rate.
USE OF PROCEEDS
VMware expects net proceeds of $741.4 million from the offering of 33 million shares, or $853.7 million if the underwriters exercise their options. EMC will consume $350 million upfront and an additional $127 million when it sells VMware its new headquarters. The rest VMware will use for general corporate purposes.
THE MANAGEMENT
Diane Greene
President, CEO and director
Co-founded the company and has headed it since its inception. She became a director in April. She has also been an executive vice president of EMC since January 2005.
Carl Eschenbach
Executive vice president of worldwide field operations
Joined in 2002 and attained his current position in 2005. Previously, he held management positions at Inktomi, 3Com, (COMS) Lucent Technologies and EMC.
Mark Peek
Chief financial officer
Joined in April from Amazon, (AMZN) where he worked for seven years. Before that he spent 19 years at Deloitte & Touche. |
