EMC Shows Slower Growth But Is Still Deeply Undervalued

by Trefis Team
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While its subsidiary VMware’s stock plunged on lower than expected Q2 guidance, EMC (NYSE:EMC) bucked the trend despite missing market expectations in its Q1 results on April 24. The company’s revenues grew 6% on a year-over-year basis to $5.4 billion. [1] However, the pace seems to be slowing down.

Overall Information Storage revenues increased 3% on a y-o-y basis on the back of higher revenues from services. In its services business, the company mainly benefited from providing support to workloads running in public clouds. Within its Information Storage segment, revenues from VMAX high-end and emerging storage, registered double-digit growth. However, what comes as a concern is that revenues from unified and backup recovery business revenues declined by 2%. This includes key products like VNX and data domain and constitutes a significant chunk of its revenue. [2]

The Information Security business saw 12% growth y-o-y driven by continued customer requirements for RSA encryption and trusted IT solutions. The Information Intelligence or Content Management segment grew 7% y-o-y after several quarters of decline. Geography wise with 8% growth, the U.S. outperformed other markets which grew by 4%. [2]

Operating margins (after adjusting for one time items) declined slightly to just below 17%, mainly due to an increase in R&D and SG&A expenditures. [1] EMC continued to add cash to its balance sheet as net cash (after removing debt from cash and cash equivalents) increased to $3.6 billion. To return more of its growing cash to shareholders, the company is on track to repurchase $1 billion of its common stock in 2013. EMC also mentioned that Pivotal, a joint venture of EMC and VMware (a subsidiary of EMC), has started its operations from April 1. [2]

We have updated our Price Estimate for EMC to $42, which is nearly 100% premium to the current market price. Below we discuss what factors will drive the growth for EMC.

See  our full analysis on EMC

Pivotal Will Help Tap Rapidly Growing Cloud Services Market

Through Pivotal, EMC and VMware are aiming to focus on Big Data and Cloud Application Platforms. IDC cloud research shows that revenue from IT cloud services is expected to reach $72.9 billion in 2015, growing at a compound annual growth rate (CAGR) of 27.6%. [3] This is over four times the growth expected for the worldwide IT market and presents a huge growth opportunity.

The formation of Pivotal will enable EMC and VMware to focus on their core competencies while pursuing the growing cloud services market. In its first year of operation, Pivotal is expected to garner almost $300 million in revenues in 2013, and up to $1 billion by 2017. [4] Pivotal also recently received $105 million investment by GE for a 10% stake, which implies the venture is already being valued at over $1 billion. [5]

Private And Hybrid Cloud Adoption To Drive Growth

Private clouds are gaining popularity as cloud computing moves to the next phase of growth. Private clouds usually involve infrastructure managed for one organization with hardware and software tailor made to meet the needs of the organization while public cloud involves multiple companies sharing space on the same servers. Through its Velocity program, the company has signed up major providers such as Verizon-Terremark, Singapore Telecommunications and AT&T to provide private cloud networks. Further, EMC is also focusing on hybrid clouds, where companies can have their own in-house private clouds to retain sensitive data and information and move the rest to a public cloud. Having access to a public cloud helps scale applications easily, and EMC claims that its hybrid cloud strategy is different from Amazon (NASDAQ:AMZN) and Oracle (NASDAQ:ORCL).

Continued Growth In VMware Will Add To Growth

VMware, in which EMC owns around 80% majority stake, has seen strong growth on the back of growing virtualization demand. While revenue growth is somewhat slowing down, we expect it to continue to see double-digit revenue growth in near term due to demand from mobile desktop virtualization, the bring-your-own-device (BYOD) movement, big data analytics and enterprise social networking pick up. Refer to our note VMware’s Growth Slows But Its Outlook Remains Strong to get full details on VMware. We believe VMWare’s value is not fully being reflected in EMC’s current stock price.

Storage Hardware: Lenovo Tie-Up To Help In Asia Pacific

In the second half of 2012, EMC and Lenovo Group entered into a strategic partnership to resell storage equipment and servers made by EMC. Currently, they are testing their products in China before expanding to other locations. China is the world’s second largest economy and EMC will gain a foothold in this massive market through this partnership. The partnership will also open up markets outside of Asia for Lenovo, and will help it expand into products beyond personal computers in Asia. The companies have also formed a joint venture to sell storage equipment to small and mid-sized businesses. [6]

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Notes:
  1. Q1 earnings, EMC, April 24 2013 [] []
  2. EMC’s CEO Discusses Q1 2013 Results – Earnings Call Transcriptt, Seeking Alpha, April 24 2013 [] [] []
  3. IDC Cloud Research, www.idc.com []
  4. EMC, VMware To Launch Pivotal Initiative As Separate $300M Firm, CRN, March 13 2013 []
  5. GE invests $105M in Pivotal to build the Industrial Internet, Venture Beat, April 24 2013 []
  6. Lenovo Forges Ties With EMC, www.businessweek.com, Aug 1, 2012 []
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