Tech is cyclical in so many ways. For starters, there is the impact of the overall economy - when times are tough, companies pull back on non-essential IT. There is also a cyclical aspect insofar as the hot space or sector. More experienced investors almost certainly remember when stocks like Cisco (Nasdaq:CSCO), Oracle (Nasdaq:ORCL) or Applied Materials (Nasdaq:AMAT) were the darlings of darlings. More recently, networking names like F5 (Nasdaq:FFIV) and cloud computing/virtualization plays like VMware (NYSE:VMW) have gotten the love.
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Why does any of this matter? Well, EMC (NYSE:EMC) is the best of breed when it comes to "Big Data" storage, and data storage is still looking like one of the strongest segments of the tech space.
A Solid Third Quarter
A lot of nervousness has surrounded names like EMC and IBM (NYSE:IBM) going into this reporting cycle, as investors have worried whether companies are pulling back on their IT spending. To that end, EMC's quarter may not have been perfect, but it was good enough to answer the loudest bears.
Revenue rose 18% this quarter, more or less matching the average analyst guess. Revenue was certainly helped by the strong growth at majority-owned VMware, while the core storage business saw 16% growth. Within that, high-end system growth was a modest 7% while mid-tier growth was stronger. More on this later.
Gross margins improved more than 2.5 points, and EMC parlayed this into 37% operating income growth and better than two points of operating margin improvement. Investors may want to note that the company is spending more on sales and marketing to keep that revenue growth coming - perhaps it's an anomaly, but it is worth watching.
Stuck in the Middle with You?
A curious flip-flop has occurred in the storage space relatively recently. NetApp (Nasdaq:NTAP) wants to move up-market and is getting more active in high-end products. At the same time, EMC (which has historically been strong in high-end) is moving more into the mid-tier business that has long been core to NetApp.
It is worth wondering, then, whether both companies are succeeding in their goals and whether NetApp is gaining some share at the high end. At the same time, IBM's sluggish mainframe sales in this third quarter (admittedly against difficult comps) makes me wonder if the IT market is getting weaker in those areas where the list prices have a lot of zeroes to the left of the decimal point.
At the same time, if EMC is seeing success going down market, that's bad news for Hewlett-Packard (NYSE:HPQ) and Dell (Nasdaq:DELL). Neither of these companies has set the IT world on fire with its storage offerings, and the erosion of the reseller relationship between Dell and EMC (as Dell emphasizes its own products) may ultimately hurt Dell more in the long run.
More Deals on the Way?
EMC has quite a bit of cash, and while more buybacks (and perhaps even a dividend) are certainly likely, more deals would make sense as well. Like other big tech players like IBM and Oracle, EMC has realized that in today's world, you have to have both the ghost (the software) and the shell (the hardware). To that end, it would not be so surprising to see EMC make a run at Sourcefire (Nasdaq:FIRE), VASCO (Nadsaq:VDSI) or KEYW (Nasdaq:KEYW), to say nothing of one of the many private companies with interesting data storage, security and retrieval technology.
The Bottom Line
At today's prices, EMC may just be one of my favorite stocks, at least among those I do not already own. There is certainly a macro risk that overall IT spending will decline if and when the economy slows further. There is also some risk of competition if NetApp is indeed doing better in the high end, not to mention the risk of "storage saturation" along the lines of how companies over-bought networking, routing and server hardware over 10 years ago.
With all of that said, though, investors should look for the best stocks in the best sectors, and EMC seems to fit the bill today. Plus, the stock does not look overpriced based on the prospects for data storage demand and VMware's virtualization technologies. (For additional reading, see A Primer On Investing In The Tech Industry.)
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