EMC = Exceptionally Managed Company
>
> The High Tech Arena 3/7/99
> By Joe Arena
> Editor
>
>
> In the arcane realm of high tech investing, many investors (including the
> great Warren Buffet) shy away from companies they cannot understand or are
> unfamiliar with. Such is the case with EMC, although considering its lofty
> valuation on a p/e basis, it can hardly be considered one of Wall Street's
> best kept secrets anymore. Borrowing a page from the book of Peter Lynch
> (i.e., if you can't explain to a 10 year old child in 30 seconds why you own a
> stock, you should not own it) That being said, consider the following
> explanation concerning EMC relative to the compelling investment premise that
> it represents.
>
> "Anytime you use the Internet to work, play, communicate, or buy something,
> you create information that must be kept somewhere. EMC is the leading maker
> of products that store this information so that it can be used to help make
> people more productive. With the Internet adding seven new users every
> second, there will be a huge need to store a lot more information, and EMC is
> in the best position to make money from this trend."
>
> Drilling down into the business of EMC reveals even more cogent reasons why
> this stock should be a long term core holding for every high tech investor.
> First and foremost, the data storage business has grown at a 90% annual rate
> over the last four years, and according to IDC, will double annually for at
> least the next 3-5 years. From a revenue standpoint, EMC has a goal of $10
> billion in 2001, up from $4 billion in 1998.
> This projection may prove to be somewhat conservative, as EMC should have a
> market opportunity of $35 billion during this time frame. This opportunity
> breaks out in terms of
> $13.5 billion for mainframe/Unix storage, $8.5 billion for server
> consolidation, $4.5 billion for PC consolidation, and $8.5 billion for storage
> software. In addition, the market for tape replacement, professional services,
> and ESN (Enterprise Storage Networks) will equate to another $6 billion in
> market opportunity in 2001, for a total of $41 billion. Assume EMC will
> secure a 35% share of this opportunity (EMC currently has 35% with IBM being
> second with 22% that is declining, no other competitor has over a 10% share)
> and the company would have sales over $14 billion in 2001.
>
> One of the most salient factors in making the bullish case for EMC has to do
> with a very favorable shift in product mix. Specifically, a transition toward
> larger capacity systems is not only resulting in greater revenue, but has been
> the key to expanding gross margins. For example, the 3700/5700 disk storage
> system, which currently supports up to 128 drives, grew from 23% of unit sales
> in to 35% of sales during 1998.
> EMC's smaller capacity disk storage product, the 3330/5330, which supports up
> to 32 drives, has declined from 20% of unit sales to 14% of unit sales in
> 1998. During the last eight quarters, this salutary change in mix has
> resulted in revenue per unit increasing from $322,000 to $424,000. Moreover,
> the addition of licensed software in the product mix has also played a
> significant role in EMC's torrid growth. During the last two years, software
> revenue per storage system has grown from $16,000 to $76,000.
>
> Another crucial element driving EMC's growth is their proprietary storage
> management software, which is also what differentiates them from the
> competition. (e.g., IBM, sunw, cpq, dell) EMC has become the fastest growing
> major software company, with 1998 revenues totaling $445 million, representing
> a compound annual growth rate of 161%.
> One of the key trends that EMC is exploiting in terms of their software
> business is that of the changing role of information technology in the
> corporate space. For example, the bar is being raised relative to how IT
> managers are evaluated. No longer are they just expected to deliver cost
> savings via personnel cutbacks or consolidation of floor space. They now must
> bring a whole new array of skill sets to the party in terms of utilizing
> information techonology to bring products to market quicker, enhance customer
> service, and improve information availability. The point here is that EMC is
> rapidly developing a relationship with its customers that is based on
> providing solutions via storage management which add to the top line as well
> as the bottom line.
>
> One of the major competitive advantages that EMC has realized is the ability
> to provide storage products that work for mainframes, Unix machines, and
> Windows NT Servers. The strengths of its competitors, conversely, are
> confined to one specific segment. For example, IBM and Hitachi are strong in
> the mainframe and Unix segment, but are weak relative to NT servers. Compaq
> and Dell are strong in the NT segment, but are not viable competitors in the
> mainframe segment. Sun Microsystems is very strong in the Unix segment, but
> not a major competitor in the high end or low end of the market.
>
> Enterprise storage is a vital market segment which EMC is focusing on, and
> have stated their goal to garner a 50% share of this business. With the
> rapidly increasing importance of e-commerce to every company, success hinges
> on the ability to efficiently and effectively locate information about
> customers, competitors, suppliers, and internal operations, regardless of
> where that information is located. In many cases, this data resides in
> distributed storage systems geographically dispersed and disparate servers,
> where instant accessibility to all users is a virtual impossibility. EMC's
> product offering to provide a solution in this area is called ESN, or
> Enterprise Storage Networks.
>
> It is also noteworthy that EMC had the foresight to recognize the growth
> potential of Windows NT, and incorporate its storage solutions to capitalize
> on this trend. More importantly, EMC believes that Windows NT/2000 will grow
> faster than any other operating system (yes, that includes Linux) and may very
> well replace Unix systems in three or four years. The significance of this is
> the growth of Windows NT/2000, which is creating storage management nightmares
> for corporate IT personnel. (MSFT is currently selling 100,000 NT servers per
> month) EMC estimates that by 2002, 44% of all servers will be running Windows
> NT/2000. Also, based on EMC estimates, storage management comprises 55% of
> the cost of such decentralized environments. However, by implementing an EMC
> solution, the cost is reduced to only 15%. Ultimately, the greater share of
> market that Windows NT/2000 achieves, the greater the competitive advantage
> realized by EMC.
>
> The greatest risk to owning EMC from an investor standpoint has to do with
> its high valuation. However, we believe that in this slow growth,
> deflationary environment, a company which could very easily more than triple
> its top line in 3 years deserves a premium multiple, especially given our
> belief that the yield on the long bond could return to levels below 5% by the
> end of the year. Furthermore, we feel compelled to reiterate one of our key
> investment tenets, "you are buying a business, not a stock." Thus, you want to
> own the greatest businesses you can find if you have a long term time horizon
> and are prepared to dollar cost average when building your position in the
> stock. We would rather pay reasonable prices for superior companies than
> bargain prices for decent companies. And given EMC's projected earnings
> growth of 35% during the next 3-5 years, a case can be argued that the current
> stock price is not excessive, especially in a liquidity driven market. The
> point here is that EMC is well on its way to becoming the Microsoft of data
> storage, and the best is yet to come. And if you had worried about the high
> valuation of Microsoft in 1986, you would never have owned the stock.
>
> TRADING UPDATE: We have taken another trading position on the MSFT Jan 01 150
> calls, purchased last week at 39 7/8. We anticipate the stock running up to
> test the old high of 175, as investors anticipate the split and there is a
> paucity of negative news due to the trial recess. We would be sellers of this
> trading position within several days after the split, however. We continue to
> hold short positions in CSCO puts, specifically the March 90, 95, 105, and
> July 105. The cash we took in shorting these puts was put to work
> establishing the MSFT long leaps calls position. We are also considering
> initiating a position in the EMC Jan 01 80 calls on margin in our trading
> account, anticipating a breakout to new highs as a result of the upcoming
> split. We will also begin shorting EMC Jan 01 85 puts, using the cash from
> this trade to begin building a long term position in the stock.
>
> DISCLAIMER: The information herein has been obtained from sources which are
> believed to be reliable, but there are no guarantees as to its
> accuracy or completeness. Neither the information nor any opinion
> expressed constitutes a solicitation for the purchase or sale of any
> security.
>
> THE HIGH TECH ARENA
> Joe Arena
> Editor
> JRArena@aol.com |
