EMC's acquisition of virtualization software maker VMware completed in January 2004 may have been one of the better deals in the technology sector in the last three years. But perhaps it's time for EMC to bid adieu.
With NCR's planned spin-off of Teradata--its data warehousing software unit and arguably most interesting part of the company-- serving as a backdrop J.P. Morgan analyst Bill Shope asked in a research report whether VMware was better off separated from its parent.
Shope's question, which was raised in a report highlighting the key technology issues of 2007, raises some interesting points. Storage company EMC landed VMware for $625 million and now has a company with some of the most talented software engineers around. Today, VMware's revenue run rate of $725 million tops the purchase price.
And what did EMC shareholders get for the sweet purchase of VMware? Less than nothing, says Shope.
"VMware could eventually become a substantial component of EMC’s overall market capitalization. While this suggests that VMware should generate incremental value for EMC’s shareholders, EMC’s stock has not seemed to benefit from this at all. Indeed, looking at EMC’s market capitalization from 2004 to the third quarter of 2006, we can see that our estimated value for VMware has increased from 2% of the total to 13% in 2006, yet EMC’s stock price fell 10% over the same time period," says Shope.
To be sure, VMware benefited from EMC's clout with enterprise customers in 2004, but ties to EMC could become a handicap as virtualization gains steam. Meanwhile, VMware's success is being diminished by the struggles of EMC, which is facing competition from HP, Network Appliance and Hitachi. As for synergies between EMC and VMware, there are none, says Shope.
According to Shope:
"EMC allows VMware to operate as a largely independent subsidiary, so that VMware can maintain crucial server and PC partnerships with EMC’s largest competitors. We believe this policy of independence has been a large reason VMware has been so successful over the past several years. Unfortunately, this policy also negates many of the synergies EMC may have enjoyed from its ownership of VMware."
Add it up and EMC has a high-flying unit that's buried by other businesses, no real synergies and diversification. However, if you're EMC there's no real rush to spin off VMware unless shareholders revolt. What'll push things along? VMware troubles in the future.
"We believe EMC now has the potential to stifle VMware’s growth. For instance, VMware may find it increasingly difficult to recruit top-level Ph.D. candidates as a subsidiary of a fairly mature East Coast company, particularly when it is competing against high-fliers such as Google. In addition, as VMware’s potential for industry dominance begins to expand, the company’s ties with EMC may begin to bother partners such as HP, Sun and IBM. These factors suggest the marginal benefits of being an EMC subsidiary may begin to diminish in 2007."