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Volume 8, Number 29 -- August 7, 2008

VMware's Sales Up 54 Percent in Q2, ESX Server 3i Hypervisor Now Free

Published: August 7, 2008

by Timothy Prickett Morgan

Facing some stiff competition on two fronts with Microsoft and Citrix Systems gunning for the X64 server virtualization budget money, VMware decided just a few days after reporting its financial results for the second quarter and a few weeks after the departure of founder and president Diane Greene that now is the right time to give away the ESV Server 3i embedded hypervisor to blunt the Microsoft and Citrix attacks on a business that VMware still owns.

For the second quarter, VMware's new president and chief executive officer, former Microsoft hotshot Paul Maritz, hosted the conference call and told Wall Street that the company's sales rose by 54 percent to $456 million, with operating income rising by 30 percent to $61 million and net income rising by 53 percent to $52 million. By geography, VMware's sales in the United States rose by 43 percent to $240 million in the second quarter, compared to 68 percent growth to $216 million in the rest of the world; the company said sales in Europe and Australia were particularly strong. Software license sales, which are comprised mostly from the tools that surround the VMware Server and ESX Server hypervisors for desktop and server virtualization, rose by 39 percent to $284 million in the quarter, while services and support sales rose by 85 percent to $172 million. Clearly, the cooling economy in the United States and price pressure on virtualization software in general are putting pressure on VMware's numbers.

Still, the second quarter was more or less on target with projections that VMware was making for 2008 a few months ago. The trouble is--and one of the likely reasons why Greene was forced out--is that projections for the second half of this year are not so rosy at VMware. The company said in its financial reports last week that looking ahead, it expected sales to grow by 42 percent to 45 percent over the $1.3 billion in sales it had in 2007, with third quarter sales to be in the range of $462 million to $468 million. VMware grew sales by 88 percent in 2007, and was expecting 50 percent growth in 2008.

Given the revenue dip, you might be asking yourself, why on earth would VMware then decide to give away the embedded version of its flagship hypervisor, ESX Server 3i? Well, it was trying to charge $495 a pop for this hypervisor, which is loaded on flash drives in servers and put inside other embedded devices that need to be virtualized. As hypervisors commoditize, which they most assuredly are doing even as hypervisors proliferate and grow more sophisticated, the hypervisor is becoming the loss-leader for the rest of the virtualization tool stack. Basically, if Microsoft is essentially giving away Hyper-V inside Windows 2008 and if VMware gets the vast majority of its sales to Windows shops desperate to virtualize and consolidate their servers because Windows does not have a decent workload management layer (like Linux, Unix, mainframes, and other proprietary operating systems have had for some time), then something has to give. In this case, two things had to give: Diane Greene and the price tag on ESX Server 3i. It will not at all be surprising when Mendel Rosenblum, the creator of the VMware hypervisor, is asked to leave or decides to do it all on his own. Dinner conversation at the Greene-Rosenblum household can't be a lot of fun right now, and these two engineers and computer scientists are way smarter than a lot of the pretenders in Silicon Valley.

Of course, this could all get crazier. Disk array maker EMC, which bought VMware in 2003 for $625 million and has run it as a subsidiary so it could take 15 percent of it public (to much fanfare last year), might itself be in play. There are rumors going around that networking giant Cisco Systems wants to buy EMC. Considering that EMC owns 85 percent of VMware, the $31 billion market cap on EMC means for maybe $40 billion, Cisco can gain control of VMware and maybe even sell off the rest of it (VMware has a market cap of $13.7 billion, so presumably EMC's stake is worth $11.6 billion). The question you have to ask is: What's more valuable, EMC or VMware? It might be cheaper to buy EMC and get VMware as part of the deal than to just buy VMware by itself. And the real question you have to ask is this: Why on earth are these companies worth so much money? EMC brought in $13.2 billion in sales and $1.7 billion in net income to the bottom line in 2007. Call me old-fashioned, but I never thought 25X multiples on earnings to calculate market value ever made sense, and I still don't.


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