VMWare: EMC’s Engine Of Growth

We have been following EMC Corporation (EMC) for the longest time since EMC is the largest and most well-known IT company in the Boston, MA area. EMC is located in the Boston suburb of Hopkinton, and one of our analysts worked next door to EMC’s Westborough office. The operation within EMC that accounts for 57% of EMC’s market capitalization is EMC’s 80% stake in VMWare, Incorporated (VMW). The reason why VMWare accounts for so much of EMC’s market cap even though it accounts for only 20% of EMC’s revenue is because VMWare is focused on the fast growing IT virtualization software and solutions segment and could be considered a “cloud-computing play.” VMWare was founded in 1998 and is headquartered in Palo Alto, CA. It was acquired by EMC in 2004 for $625M and EMC floated 10% of VMWare’s shares in an IPO in August 2007. VMW’s shares went from $29 at its IPO to $125.25 in October 2007 before declining to $17.25 in November 2008. VMWare’s shares have since recovered and reached a near-time high of $118.79 in April before easing back to $85 at the end of October. VMWare also recently hired Jonathan Chadwick away from Skype by way of McAfee and Cisco Systems (CSCO) to serve as its first CFO.

VMWare’s Q3 2012 results were a bit of a mixed bag. On one hand, the company had posted 29% revenue growth in its Services revenue as well as a 33% increase in its gross margin dollars from services. On the other hand, License revenue only grew by 11% and its licenses gross margin % eased downward by nearly 2%. On one hand, the company’s total revenue increased by 20% year-over-year. On the other hand, three of its expense categories grew at a faster rate than revenue, one grew at a similar rate to revenue and only one grew at a slower rate than revenue. However, we have taken note that the fact that company’s expenses grew at a faster rate than its revenue was due to increased equity-based compensation expenses. Equity-based compensation expenses grew by nearly 50% year-over-year and if we take these expenses out of VMWare’s total expenses, we see that VMWare’s operating expenses increased at roughly the same rate as revenue.

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