EMC Earnings Preview: VMware, Pivotal To Drive Results As Storage Business Remains Depressed

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EMC (NYSE:EMC) is scheduled to announce its third quarter earnings on Wednesday, January 27. [1] Over the last few quarters, EMC has witnessed a slowdown in its core information storage business, with its subsidiary VMware (NYSE:VMW) driving much of the growth. The net revenues generated by EMC’s information infrastructure segment, which includes product and services revenues for storage hardware, content management and information security, fell by 1% on a y-o-y basis to $12.8 billion through the first three quarters of the year. On the other hand, the combined revenues of VMware and Pivotal were up almost 11% to just under $5 billion in the same period. The trend is expected to continue through the December quarter given the weak global spending on storage hardware.

Despite the slowdown 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 (including a possible negative impact of foreign exchange). However, the company revised its full year revenue guidance to about $25 billion at the end of Q2, with a negative impact of almost $550 from FX fluctuation. [2]

At the begininning of the December quarter, EMC came to an agreement with IT giant Dell under which the latter will acquire EMC for $67 billion. Under the conditions of the deal, 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 was announced at about $33.15 per EMC share.

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Information Infrastructure Revenues To Remain Suppressed

Storage systems manufacturers such as EMC, NetApp (NASDAQ:NTAP), IBM (NYSE:IBM), Hitachi Data Systems and HP (NYSE:HPQ) have had a tough year in terms of storage hardware product sales, owing to a decline in worldwide spending on information storage. According to data compiled by IDC quarterly reports, global factory revenues for storage systems declined by over 2% y-o-y to about $17 billion through the first three quarters of 2015. [3] [4] [5] Consistent with the trend, EMC’s storage hardware revenues in the same period fell by about 6% y-o-y to $4.9 billion. As a result, EMC’s information storage product revenues (hardware and software combined) were down by over 4% y-o-y to  $7.1 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 the first three quarters of 2015, as EMC’s share fell to 28.8% for Q1, Q2 and Q3 combined. Most large storage systems providers including EMC, NetApp, IBM and Hitachi Data Systems lost share to ODM direct sellers that sell to hyperscale datacenters in recent quarters.

EMC To Bank On VMware, Pivotal For Growth

VMware’s revenues grew by 11% year-on-year to $4.8 billion through the first three quarters of the year. VMware’s management expects the growth spree to continue in Q4 as well, with revenues expected to increase by 8-10% y-o-y to about $1.9 billion, with its services division driving much of the growth (see: VMware Earnings Preview: Shareholders Uneasy Despite Expected Growth). Management expects continued growth in software-defined networking, hybrid cloud and end-user computing, as evidenced by its results through 2015.

Pivotal has been the fastest-growing division for EMC over the last couple of years, with a 27% growth in net revenues to $227 million in 2014. The trend continued through the first three quarters of 2015, with net Pivotal revenues rising by 15% y-o-y to $185 million. Within Pivotal, product sales grew by 33% on an annual basis to $57 million while services revenue was up by 8% over the prior year period to $128 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.

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Notes:
  1. EMC To Announce Fourth-Quarter Financial Results On January 27, EMC Press Release, January 2016 []
  2. EMC Earnings Call Transcript Q2 2015, Seeking Alpha, July 2015 []
  3. Worldwide Quarterly Disk Storage Systems Tracker Q1 2015, IDC Press Release, June 2015 []
  4. Worldwide Quarterly Disk Storage Systems Tracker Q2 2015, IDC Press Release, September 2015 []
  5. Worldwide Quarterly Disk Storage Systems Tracker Q3 2015, IDC Press Release, December 2015 []