VMware's IPO: Converting Virtual Machines into Real Money

Published: August 21, 2007

by Timothy Prickett Morgan

The VMware server and workstation virtualization subsidiary of disk array maker EMC made a big splash on Wall Street last week as it went public. The company announced early last Monday morning (when we were on holiday) that it had priced its shares at $29 a pop, and EMC cashed in on the growing popularity of virtualization technologies as companies seek to increase the utilization and reduce the power consumption of their IT hardware.

VMware could have picked a better week to go public, with the stock markets around the globe bleeding off market capitalization as the sub-prime mortgage lending crisis is causing the major markets a bad case of the jitters. But as far as Wall Street is concerned, the addition of the excitement of VMware to the roster of publicly traded companies could not have come at a better time. The stock market needs some good news--that's for sure.

EMC announced back in February that it was selling off a 10 percent stake in its famous VMware subsidiary, which was never fully integrated into EMC and which has operated with its own books since being acquired. At the time, EMC said that it was unhappy with its own valuation, which is based on its dominant position in external disk arrays used in data centers as well as VMware and a number of other software businesses that bring EMC sales and profits. The spinoff was intended to unlock some of the value inherent in the VMware mix, and it has certainly done that. EMC's stock rose on the news that it was selling off a chunk of VMware, and it has risen more or less steadily as the year has progressed. Like other stocks, EMC's stock has taken a hit as the markets cope with the mortgage crisis, so it has given back a small portion of its gains. But on the whole, EMC's stock has done well, and on Thursday morning as I write this, the company's shares are trading at around $18, giving EMC a market capitalization of $38.5 billion. That's not too shabby for a hardware company with software aspirations that brought in $11.2 billion in sales and $1.2 billion in net income in 2006.

VMware may have priced its shares at $29 each, but they came out trading on the Nasdaq national market under the symbol VMW at $52 apiece on Tuesday, then shot up to $55; after some profit taking, shares dropped to $51. On Wednesday, VMware shares rose to $59 and bounced around there for a while, and fell in early morning trading to $55 as the market took some more hit points over bad mortgages and the private equity funds that are indirectly linked to them. EMC sold off the 10 percent of its shares. On paper, VMware is worth around $19 billion as we go to press, including the big stakes acquired by chip maker Intel and networking gear provider (and minor server virtualization player) Cisco Systems. This is just an incredible number, considering that VMware had sales of only $703.9 million and a net income of $85.9 million in 2006. But, VMware does have 20,000 paying virtualization customers and over 200 partners in the IT racket, and its name is virtually synonymous with virtualization. (OK, you get to do that joke just once.) So that has to be worth something. And a lot, mind you.

But $19 billion seems to be excessive. Say VMware was worth a multiple of 10 times revenues. To get that valuation, VMware would have to sell several million licenses of its Infrastructure 3 stack, which can cost close to $6,000 per server. With add-ons and services, it can go even higher. Even among companies with hundreds and thousands of servers to virtualize, VMware would have to add many tens of thousands of customers per year, each installing hundreds of its software licenses, to justify the current valuation placed on VMware. It will be interesting to see if this valuation holds, and if EMC will be tempted to sell some of the remaining 90 percent of VMware it owns. EMC already did this for Intel and Cisco. Can stakes by Advanced Micro Devices, IBM, and Hewlett-Packard be far behind? The wonder is that these companies didn't get on the gravy train ahead of the VMware IPO. They could have almost doubled their investment.

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