There's that unpredictable moment in a growth tech stock's life where investors and analysts go from assuming that the trees will grow to the sky to assuming that the lumberjacks are already on site. That may not yet be the case for VMware (NYSE:VMW), but it definitely seems that sell-side analysts are no longer racing to top each others' growth estimates and that there's an increasing concern about the underlying growth of the market.

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A Mostly Solid Close to the Year
VMware reported that total revenue grew 27% this quarter and almost 13% from the September quarter. License revenue rose 22%, but this basically just met the expectations. One of the good news/bad news situations is that VMware is seeing an increasing amount of service and maintenance revenue. This a lucrative stream of revenue for any company, but investors don't tend to prize that much at companies like CA (Nasdaq:CA) or Microsoft (Nasdaq:MSFT).

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Profitability continues to expand nicely. Operating income jumped 64% from last year (and 18% sequentially), as the company expanded its operating margin more than four and a half points from last year. (For more on operating margins, see A Look At Corporate Profit Margins.)

Looking at some other metrics, billings rose 29% and deferred revenue rose 46%, with ELA bookings jumping 49%.

Slowing Servers
One of the sources of concern around VMware in 2012 is the slowing server market. IBM's (NYSE:IBM) recent report wasn't encouraging on the server market, and the commentary from Microsoft and Intel (Nasdaq:INTC) from their respective quarters was somewhat mixed.

The thought here is that while VMware has plenty of penetration yet to achieve, as well as ancillary growth opportunities, fewer server sales ultimately crimp the addressable market. It's a reasonable theory, but it seems a little early in the virtualization story for that to really swing to near-term performance. After all, the general estimate is that about half of the market has been penetrated and that VMware has something like 50 to 55% share (versus 25% for Microsoft and maybe 20% share for Citrix (Nasdaq:CTXS).

Can Step-Out Sales Boost the Growth Opportunity?
As VMware matures, it will need to find new avenues for growth. Desktop virtualization is one possibility, though the company hasn't seen quite the same growth here yet. A bigger opportunity could be in expanding vCenter into management tools for system management. This is a big market for IBM, CA and BMC (Nasdaq:BMC), but also a logical target for VMware. Operators of heterogeneous systems will probably stick with CA and BMC a while longer, but it's more than a $10 billion market so it's not an entirely zero-sum game.


The Bottom Line
Oracle (Nasdaq:ORCL) and Red Hat (NYSE:RHT) have made the market a little nervous about enterprise software stories in 2012. Still, the performance and cost savings advantages of virtualization in data centers is compelling, and it stands to reason that VMware's products will sit near the top of most IT budget priorities.

VMware isn't, and really never has been, cheap by most metrics. The stock is a little undervalued on the basis of an assumption of better-than-10% compound free cash flow growth over the next decade, but arguably at risk of falling into that twilight zone of too expensive for valuation-sensitive investors and maybe too mature for growth momentum speculators. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.