EMC Earnings Preview: Focus On What Lies Ahead Post-Dell Takeover

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EMC (NYSE:EMC) is scheduled to announce its second quarter earnings on Wednesday, October 21. [1] The company has witnessed a slowdown in its core information storage business over the last few quarters, with its subsidiary VMware (NYSE:VMW) primarily driving results. Earlier this month, EMC came to an agreement with IT giant Dell, under which the latter will acquire EMC for $67 billion. Dell’s board has decided to keep VMware a publicly traded company for now. Following the news of the acquisition, EMC released its preliminary Q3 results with revenues expected to be roughly flat over the prior year period at just over $6 billion. [2]

We have a $28 price estimate for EMC, which is in line with the current market price. EMC’s stock price has risen by about 15% this month following initial speculation about the takeover.

See our full analysis for EMC’s stock

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Information Infrastructure Revenues To Remain Suppressed

EMC’s information storage product and services revenues combined through the first half of the year stood at just under $7.7 billion, flat over the comparable year-ago period. Within information storage, services revenues grew by 7% to $3 billion while product revenues (hardware and software combined) fell by over 3% y-o-y to $4.7 billion. The company has been a clear leader in the external storage systems market over the last few years, with its share growing from under 23% in 2009 to over 31% in 2014. However, EMC lost market share in the external storage systems market through 2014, with its share declining by 30 basis points from 2013 levels of 31.3%. This was the first time since 2008 that EMC’s share in this market segment declined on a y-o-y basis. This trend continued through Q1 and Q2 this year, as EMC’s share fell to under 28.5% through the first half of the year. Correspondingly, EMC’s storage hardware revenues fell by over 5% on a y-o-y basis to $3.2 billion. [3] This was evident across major storage systems providers including NetApp (NASDAQ:NTAP), IBM (NYSE:IBM), Hitachi Data Systems and Hewlett-Packard (NYSE:HPQ), which lost share to ODM direct sellers in recent quarters. The combined share of Dell-EMC in the external storage systems market could potentially be over 35% of the market once the acquisition completes.

Despite a slowdown in global spending on information storage and stagnation in EMC’s core businesses, the company initially had a positive outlook for the coming quarters. At the end of Q1, management expected net revenues for the full year to rise by almost 7% y-o-y to over $26 billion in 2015 despite a possible negative impact of foreign exchange. However, the company revised its full year revenue guidance to about $25 billion, with a negative impact of almost $550 from FX fluctuation. [4] With its core business slowing, the company has remained optimistic about its emerging storage division and expects revenues generated by emerging storage to continue to outperform core storage with an expected 30% growth rate this year and a high teens growth rate over the next few years. In the most recent quarter, EMC witnessed a 49% year-over-year increase in its emerging storage product sales, which include the all-flash array XtremIO, scale-out network attached storage platform Isilon and converged storage infrastructure ScaleIO.

Solid Growth Expected From VMware, Pivotal

While the core business remains stagnant, strong growth is expected from software and services-intensive businesses, particularly VMware. VMware’s revenues grew by 11% year-on-year to nearly $3.1 billion through the first half of the year. The company expects the growth spree to continue in Q3, with revenues expected to increase by 10% y-o-y to just under $1.7 billion, with its services division driving much of the growth (see: VMware To Beat Guidance On Revenue, EPS Based On Preliminary Earnings Release). Management expects continued growth in software-defined networking, hybrid cloud and end-user computing, as evidenced by its results through 2014.

Pivotal was the fastest-growing division for EMC last year, with a 27% growth in net revenues to $227 million. The trend has continued in 2015 thus far, with net Pivotal revenues rising by over 13% to $118 million through the first half of the year. Within Pivotal, product sales grew by 38% on an annual basis to $36 million while services revenue was up by 5% over the prior year period to $82 million. The company attributed this rise to a higher number of subscription-based sales as compared to standalone licenses in addition to Pivotal increasingly becoming key to cross-EMC solutions. Although standalone services were flat over the prior year period, the company expects the growth to continue through the coming quarters, further boosting revenues of Pivotal Labs and Pivotal Cloud Foundry.

Highlights Of The Dell Deal, Impact On VMware

EMC shareholders will receive $24.05 per share in cash in addition to a tracking stock related to VMware. For each EMC share, shareholders will receive about 0.111 shares of VMware’s new tracking stock (note: VMware’s stock was trading around $78-82 through the week prior to the announcement). As a result, the total combined purchase price stands at $33.15 per EMC share, taking the total value to $67 billion. [5]

EMC had an 80% stake in VMware, with 97% voting rights. With Dell acquiring EMC, it has effectively acquired the 97% voting rights but floated over 50% of VMware’s stock as tracking stock with no voting rights. Under the conditions of the deal, Dell would have a 28% stake in VMware with 97% voting rights, while existing VMware shareholders retain the 20% ownership with 3% voting rights. Over 50% ownership will lie with former EMC shareholders in the form of tracking stock and no voting rights. [6]

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Notes:
  1. EMC To Announce Third-Quarter Financial Results On October 21, EMC Press Release, October 2015 []
  2. EMC Pre-Announces Third-Quarter Financial Results, EMC Press Release, October 2015 []
  3. Worldwide Quarterly Disk Storage Systems Tracker Q2 2015, IDC Press Release, September 2015 []
  4. EMC Earnings Call Transcript Q2 2015, Seeking Alpha, July 2015 []
  5. Billionaire Michael Dell Strikes $67B Deal For EMC In Biggest Tech Buy On Record, Forbes, October 2015 []
  6. Dell Will Issue a Lot of Not-Quite-Stock to Pay for EMC, Bloomberg View, October 2015 []