Volume 4, Number 6 -- February 13, 2007

EMC's VMware IPO Spin Off: The Birth of a New Bubble?

Published: February 13, 2007

by Timothy Prickett Morgan

EMC, which is perhaps best known for its disk arrays and some of the software it has acquired in the past few years, such as VMware for server and workstation virtualization, Legato Systems for tape backups, and Documentum for information lifecycle management, is a bit frustrated that Wall Street doesn't correctly value EMC's portfolio of products. And so, it is selling of a 10 percent stake in VMware, perhaps its hottest item, in an initial public offering.

In 2006, the VMware unit had $709 million in sales, up 83 percent, and with the launch of the Infrastructure 3 product set, which is based on its ESX Server 3 hypervisor and lots of add-on goodies, in the fourth quarter, the VMware unit saw revenue growth of 101 percent. EMC doesn't say how much profits VMware generates, but presumably the number is high and definitely once VMware does an IPO, we will be able to open the S1 filing with the Securities and Exchange Commission to see just how much profits there are.

EMC may eventually regret this move.

"VMware is one of the fastest-growing businesses in the history of the software industry," explained Joe Tucci, EMC's president, chief executive officer, and chairman. "We expect the IPO to unlock more of VMware's value for EMC shareholders while also strengthening its ability to retain and attract the software industry's top talent." EMC says it is only selling a 10 percent stake and will not sell any more.

Everyone in IT already knew EMC owned VMware, so presumably the value of VMware was in the EMC stock price. It is hard to say how much VMware is worth, but it is probably on the order of several billion dollars, particularly if the company is wickedly profitable. It could be as much as $5 billion to $7 billion based on some of the ridiculous multiples that public companies have related to reveneu streams. But, if VMware's stunning growth has come by sacrificing profits, then Wall Street will be cooler to VMware's IPO, which means it won't be worth as much.

The news of the pending IPO raised EMC's share price by a buck a share or so, and as we go to press, EMC has a market value of nearly $31 billion. In the twisted, self-referential, pretzel logic of Wall Street, a sizeable portion of the value of the future VMware IPO is today in the EMC share price, since the stock went up on the news. If anything, the IPO should have caused EMC's price to go down, since some of the value of the total company was going to be sold off. If VMware is worth $5 billion, and Wall Street buys $500 million in stock from an IPO, then isn't the value of the EMC parent diminished by $5 billion? Don't the accounts have to balance, since EMC already owns VMware?

Not on Wall Street, not in Silicon Valley, and not in Boston. And not among the investors who will be clamoring for VMware's shares when they go public, and those who buy and sell them many times after that.

EMC was a radical innovator in storage arrays two decades ago, and once had a market capitalization that equaled Microsoft, Sun Microsystems, and General Motors--who were all valued at more than $200 billion during the dot-com boom. The mistake is to think that this was normal, correct, or desirable.

And now EMC may start a whole new trend. How long before companies that are already public start selling off valuable pieces of themselves--pieces that shareholders already own--hoping no one thinks to balance the accounts? This could be the beginning of a whole new bubble. Best to carry a pin. Or, ignore it all and hope your 401(k) account goes up.

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Editor: Timothy Prickett Morgan
Contributing Editors: Dan Burger, Joe Hertvik, Kevin Vandever,
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