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.

Related Articles
  1. Personal Finance

    How Tech Can Help with 3 Behavioral Finance Biases

    Even if you’re a finance or statistics expert, you’re not immune to common decision-making mistakes that can negatively impact your finances.
  2. Investing

    How to Spot Secular Bull Markets vs. Secular Bear Markets

    A guide to identifying secular bull and bear markets.
  3. Investing

    What's Better Facebook Moments or Google Photos ?

    Facebook and Google have both released new cloud-based photo sharing services. How good are they?
  4. Brokers

    The Next Industries Bound to be Uberized

    As more startups succeed with the sharing economy business model, investors seek out businesses poised to disrupt their industries like Uber.
  5. Investing

    Will Facebook's New App Leave Siri in the Dust?

    Currently Facebook is testing its new super intelligent virtual assistant, known as, "M". Can this new AI on the block dethrone Apple's Siri?
  6. Investing

    Smart Farming Technology Storms Silicon Valley

    Silicon Valley may be known for growing tech startups, but now the iconic region is welcoming an entirely new breed of residents, startups focusing on smart farming.
  7. Investing News

    Apple and the Battle for Streaming Music

    Spotify, Apple, Youtube and Tidal are facing off for control of a vast market. What factors will determine who emerges as the leader in streaming music?
  8. Investing

    The Semiconductor Sector is On the Verge of a Breakout

    The semiconductor sector may be on the verge of a major breakout that provides market leadership in 2016.
  9. Investing

    10 Tips for Creating a Strong Digital Brand When Job Hunting

    A polished resume and cover letter are no longer enough. Companies want candidates with a strong digital brand.
  10. Chart Advisor

    These Technology Stocks are Rolling Over

    These technology looked to have topped out, and could be heading lower.
  1. Is Apple Pay safe and free?

    Apple Pay is a mobile payment system created by Apple to reducing the number of times shoppers and buyers have to pay for ... Read Full Answer >>
  2. What is the QQQ ETF?

    The PowerShares QQQ, previously known as the QQQQ, is a widely held and traded exchange-traded fund (ETF) that gives investors ... Read Full Answer >>
  3. Why does Warren Buffett largely avoid investing in the technology sector?

    Warren Buffett has often said that he avoids investing in the technology sector because he does not like to own stocks in ... Read Full Answer >>
  4. How are HBO, Amazon and Google working to overtake Netflix?

    Netflix (NFLX) is one of the largest distributors of "on demand" movies, TV shows and media, as well as DVD rentals. The ... Read Full Answer >>
  5. Why doesn't Warren Buffett own Apple (AAPL) stock?

    Warren Buffet claims he simply does not know how to properly evaluate Apple (AAPL) and does not feel confident in his reading ... Read Full Answer >>
  6. What economic factors influence corporate bond yields?

    The most telling signs that a tech stock is about to burst are no different from the signs of impending collapse of stocks ... Read Full Answer >>

You May Also Like

Trading Center