EMC (NYSE:EMC) is due to release its Q2 earnings on July 24. We expect revenues to clock mid single-digit growth primarily on services revenues and the virtualization market. Revenue from services are expected to show robust growth even as the core hardware business may continue to reel under pressure. EMC owns nearly 80% stake in virtualization market leader VMware (NYSE:VMW), which continues to benefit from growing virtualization. The information security business is expected to outpace the overall revenue growth with continued requirements for RSA encryption and trusted IT solutions. The U.S. is expected to remain the major growth driver as companies in other countries reduce their IT spending by a wide margin. Operating margins (after adjusting for one time items) may remain under pressure as EMC is aggressively investing in R&D while expanding its sales force. Below we discuss the major trends for the quarter in detail.
Muted Growth In Information Storage Business
We expect the information storage business to report muted growth due to the slowdown in unified and backup recovery businesses. Many companies are cautious about economic recovery and have withheld/reduced their IT spending. However, revenues from VMAX high-end and emerging storage businesses are expected to register double-digit growth. EMC acquired XtremIO in mid 2012 to improve its flash memory storage offerings, and this is driving growth in its high-end storage network. The services part of this business is also expected to show decent growth. The company provides services to clients using its hardware and software and therefore generates recurring revenue from them. Further, as public clouds continue to grow, the company will continue to benefit from providing support to workloads running in public clouds.
We will keenly watch EMC’s performance in China to gauge the extent to which the partnership with Lenovo has benefited EMC. In the second half of 2012, EMC and Lenovo Group entered into a strategic partnership under which Lenovo will resell storage equipment and servers made by EMC. The companies have also formed a joint venture to sell storage equipment to small and mid-sized businesses. China is the world’s second largest economy and by strengthening its market presence, EMC is trying to give impetus to its growth. The partnership also opens up markets outside of Asia for Lenovo and will help it expand into products beyond personal computers in Asia.
VMware: Slowing Growth Could Be A Concern
VMware, one of the leading desktop virtualization companies, has seen strong growth on growing virtualization demand. While we expect growth to remain at a high single digit in Q2 and the near future, the long-term growth may come under pressure with its key virtualization market maturing. Growing competition is also a key area of concern for VMware. VMware will release its earnings on July 22 and we are keeping a watch on updates on certain products, which are expected to drive growth going forward. Read our note VMware Earnings Preview: Updates On Growth Drivers Needed for further details.
Eyes On Cloud Performance
EMC has also started focusing on clouds to offset slowing growth in its core businesses. The company is concentrating on private as well as hybrid clouds. While public cloud involves multiple companies sharing space on the same servers, private clouds usually involve infrastructure managed for one organization with hardware and software tailor-made to meet the needs of the organization. Under its Velocity program, the company has signed up major network providers such as Verizon-Terremark, Singapore Telecommunications and AT&T to provide private cloud services. Hybrid clouds are also gaining traction as 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. We will keep a watch on its performance in the cloud market.
We currently have a $42 price estimate for EMC, which is a substantial premium to the current market price. We recently discussed in a note (Read EMC’s Capital Return Plans Are Another Sign That Its Shares Are Undervalued) on why we believe the stock is significantly undervalued at the current market price.