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VMWare's Vaporous Valuation
A large percentage of investors call themselves GARP (that is, "growth at a reasonable price") investors, but there is a big difference between those who focus on the "-arp" and those who focus on the "guh". Fast-growing software company VMware (NYSE:VMW) highlights this dichotomy, as there is no question about the torrid growth here (and the potential for more), but quite a fertile field to argue about just how reasonable the price is right now.
IN PICTURES: Eight Ways To Survive A Market Downturn
The Quarter that Was
Forget the "yeah ... but" quarters you have seen from other companies in this earnings cycle, VMware delivered pretty much anything a growth investor could want. Revenue jumped 48% from last year, as the company saw strong renewals in enterprise license agreements and balanced growth across both the license and service segments.
Software is typically a very profitable sector, and VMware is certainly no exception. Gross margin came in at 82.5%, which was only a slight improvement from last year's level but quite high on an absolute level. Even as the company put more money into R&D and marketing, operating income nearly tripled from the year-ago level.
Sunny, or Partly Cloudy?
There is no question that VMWare has entranced investors with its incredible market share (likely around 80%) in the server virtualization market and its role as an enabler in cloud computing - the current "next big thing". Moreover, it is not hard to build an ongoing growth case for VMware on both increasing penetration of server virtualization, but also targeting companies like Citrix (Nasdaq:CTXS) in the virtual desktops market.
That is all well and good, but it is not as though VMware's success has escaped the notice of others. Microsoft (Nasdaq:MSFT) and Oracle (Nasdaq:ORCL) are both keenly focused on getting their piece of this burgeoning market, to say nothing of smaller (and arguably more nimble) companies like Red Hat (NYSE:RHT). While I appreciate that competitors will take different angles of attack on VMware and there might not be a single straight-up competitor today, I can say with confidence that there are few cases where companies have maintained 80% market shares in any growing market of the technology sector. (For related reading, see Is Cloud Computing An Investable Trend?)
Even with the looming threat of eventual competition, I think VMware can make plenty of hay while the sun shines. VMware offers a suite of products that ultimately reduce costs and improve efficiencies for companies and that is like manna from heaven - particularly in economic environments where top line growth may be hard to get and controlling costs is even more vital. So even though the overall tech spending market could be vulnerable to a second bout of weakness in theU.S.
The Bottom Line
While I get the growth story with VMware, I just cannot understand paying these kinds of multiples for a software company. Perhaps I remember too much of the last tech bubble, but I just cannot recall all that many companies that have been able to "grow into" such robust multiples as what VMWare stock carries today.
It becomes even more puzzling to me when I factor in EMC's (NYSE:EMC) 85% ownership of VMWare. I realize VMware is the growth darling of the day and does not have the cyclical or competitive concerns of EMC, but it seems strange that EMC is valued at about $40 billion in the market and VMware is valued at $30 billion. If I am thinking about this correctly, that means the market is giving a $15 billion valuation to EMC's non-VMW business; a business that could produce over $12 billion in revenue this year.
With that sort of dichotomy in place, maybe EMC is the growth-at-a-reasonable-price stock, while VMWare is just about the growth. (For more, see Stock Picking Strategies: GARP Investing.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
IN PICTURES: Eight Ways To Survive A Market Downturn
The Quarter that Was
Forget the "yeah ... but" quarters you have seen from other companies in this earnings cycle, VMware delivered pretty much anything a growth investor could want. Revenue jumped 48% from last year, as the company saw strong renewals in enterprise license agreements and balanced growth across both the license and service segments.
Software is typically a very profitable sector, and VMware is certainly no exception. Gross margin came in at 82.5%, which was only a slight improvement from last year's level but quite high on an absolute level. Even as the company put more money into R&D and marketing, operating income nearly tripled from the year-ago level.
Sunny, or Partly Cloudy?
There is no question that VMWare has entranced investors with its incredible market share (likely around 80%) in the server virtualization market and its role as an enabler in cloud computing - the current "next big thing". Moreover, it is not hard to build an ongoing growth case for VMware on both increasing penetration of server virtualization, but also targeting companies like Citrix (Nasdaq:CTXS) in the virtual desktops market.
Even with the looming threat of eventual competition, I think VMware can make plenty of hay while the sun shines. VMware offers a suite of products that ultimately reduce costs and improve efficiencies for companies and that is like manna from heaven - particularly in economic environments where top line growth may be hard to get and controlling costs is even more vital. So even though the overall tech spending market could be vulnerable to a second bout of weakness in the
The Bottom Line
While I get the growth story with VMware, I just cannot understand paying these kinds of multiples for a software company. Perhaps I remember too much of the last tech bubble, but I just cannot recall all that many companies that have been able to "grow into" such robust multiples as what VMWare stock carries today.
It becomes even more puzzling to me when I factor in EMC's (NYSE:EMC) 85% ownership of VMWare. I realize VMware is the growth darling of the day and does not have the cyclical or competitive concerns of EMC, but it seems strange that EMC is valued at about $40 billion in the market and VMware is valued at $30 billion. If I am thinking about this correctly, that means the market is giving a $15 billion valuation to EMC's non-VMW business; a business that could produce over $12 billion in revenue this year.
With that sort of dichotomy in place, maybe EMC is the growth-at-a-reasonable-price stock, while VMWare is just about the growth. (For more, see Stock Picking Strategies: GARP Investing.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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