Between lower guidance after the fourth quarter and the weak hardware results reported by Armonk, N.Y.-based International Business Machines Corp. (NYSE:IBM) about a week ago, there was no particular reason to expect a strong quarter from Hopkinton, Mass.-based EMC Corp. (NYSE:EMC). Although this storage leader did a little better than expected, it wasn't a particularly strong quarter and investors aren't liking that guidance is weighted toward the second half.

EMC remains stuck in that tech stock valuation grey zone, where investors want little to do with a company posting sluggish top-line growth and weak operating results. To put it in perspective, EMC could never grow its free cash flow again (0% growth) and would still be undervalued at a discount rate of 11%. That seems like an exceptional amount of pessimism for a well-run company, but investors considering the shares need to appreciate that revenue growth, not free cash flow, is likely to key to unlocking more value here.

Decent Results In A Seasonally Weak Quarter

It's not uncommon for EMC's first quarter to show a significant deceleration from the fourth quarter, and this time was no exception. Revenue rose 2% year-over-year, but declined 18% sequentially. Core info infrastructure revenue fell 2% yoy on a 3% decline in the storage business. Palo Alto, Calif.-based VMware, Inc. (NYSE:VMW), of which EMC still owns about 80%, was the source of the growth this quarter, as revenue rose 16%.

Margins were a little shaky. Gross margin (non-GAAP) fell 30 basis points from the year-ago quarter, matching expectations. While its small information intelligence and RSA cryptography businesses saw some improvement, the core storage and VMware businesses were both down year on year. Operating income fell 10%, as the company increased both SG&A and R&D by mid-to-high single-digit percentages, leading to an operating margin about a half-point below expectations.

A Market Leader, But The Market Is Changing

With market share somewhere around 25% to 30%, EMC is the king of the storage mountain. IBM has lost considerable momentum over the years and has seen its share fall to about 12% (3rd place). Hewlett-Packard Co. (NYSE:HPQ) can still be competitive in some limited segments, but is a distant rival in 4th place with 10% share.

NetApp Inc. (Nasdaq:NTAP) is the more vital and viable rival, though the company's approximately 13% share is well behind EMC. NetApp has generally been more competitive in the mid-range segment of the market, and most customer and reseller surveys suggest that when NetApp wins business from EMC, it is often on the basis of price and ease of use.

NetApp or even Hewlett-Packard, or smaller up-and-comers like Nimble Storage, Inc. (Nasdaq:NMBL), are legitimate players, but the changing nature of the storage market could be the bigger threat to EMC. Companies like Seattle-based, Inc. (Nasdaq:AMZN) that offer cloud-based platform services such as storage threaten EMC's enterprise business. Amazon allows enterprises to pay only for what they need as opposed to the traditional model where companies “buy for growth” and then add capacity again later.

Many Irons In The Fire

The good news for long-term EMC shareholders is that the company has many irons in the fire that could lead to long-term growth and help it keep up with the market's evolution. VMware may be the best example, as the company looks to transition beyond its legacy virtualization business, but it's not the only one.

Pivotal, a new business that incorporates data fabrics, application fabrics and cloud apps to be an “OS for the cloud,” currently addresses an $8 billion market growing at around 7% to 8% a year, but is annualizing at only about $200 million in revenue. Within EMC, ViPR offers a credible approach to software-defined storage, while the Nile web-scale storage solution (due to launch this year) promises a lower overall cost of ownership and competitive pricing to Amazon.

There is also the RSA Security business to consider. A decent-sized business in its own right (about $1 billion per year in revenue), RSA addresses a nearly $13 billion market for solutions in identity and access management (with its SecureID business), as well as security and vulnerability management and messaging. The company's relationship with the National Security Agency has done it no favors on the PR side, but it could still represent a credible independent platform for growth in IT security.

The Bottom Line

On a cash flow basis, EMC looks exceedingly cheap. EMC is priced for no free cash flow growth at all and looks exceptionally cheap on the basis of even modest growth. The “but” is that's not how investors often select tech stocks, and the company's weak near-term revenue and operating growth prospects loom large in the stock's performance. There's no denying that there are more dynamic tech stories out there but EMC remains a very good company and investors' patience should be rewarded.

As of this writing, the author owns shares of EMC.

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