VMware (NYSE:VMW) has had a strong year so far and its financial results showed the effect of growing virtualization demand. In its most recent quarter filing, it reported a 22 percent y-o-y revenue growth which came in at $1.12 billion. Free cash flows were up 29 percent y-o-y at $2 billion. U.S and international revenues grew 22 percent y-o-y to $551 million and $572 million respectively. Enterprise license revenues experienced a growth of nearly 30 percent y-o-y and license revenues came in at $517 million and services revenue was $605 million. 
The stock opened this year at around the $87 mark and it hit a high of $118 before it dropped back down to the $87 mark and has been trading in a narrow range since then. We believe that the stock is undervalued at its current levels and is worth $112 based on its leadership position in the virtualization business, mobile desktop virtualization and software defined data center initiatives.
VMware Maintains Leadership Position In A Fast Growing Market
Though the company does not enjoy the same dominance and market share it did just a few years ago, it is still the top player in the virtualization space by a far margin. Competition from Microsoft, Citrix and Oracle has taken some market share away, but the company still holds about 60-70% of the market with medium sized companies as well as high market share among large companies, albeit just a little lower. Gartner’s Magic Quadrant report states that virtualization workloads will grow five-fold by 2015, and this is a very large growth opportunity for VMware. 
Software Defined Datacenters Key To Virtualization
VMware has been making acquisitions in the software defined data center space and has acquired companies such as Nicira and DynamicOps in the past few months. These companies use software to abstract hardware resources and pools it into aggregate capacity which can be used efficiently as needed. Customers gained by the acquisitions include AT&T, DreamHost, eBay, Fidelity Investments, NTT and Rackspace. Software defined data centers are a key innovation in the virtualization space, and we expect this to support revenues in the coming quarters.
Big Data Analytics Offering
VMware has entered the big data analytics space with the acquisition of Cetas. Big data analytics is currently used by very large companies for processing massive amounts of data and is a fairly expensive feature to deploy and maintain. The Cetas software however is designed to run on virtual resources like Amazon Web Services and VMware’s vSphere, making it easier to scale and cheaper to use. This acquisition makes sense for VMware as its applications are deployed on the vSphere and provide another opportunity to cross-sell. This cost efficiency and an Analytics-as-a-service model will open up the market for small and medium enterprises, satisfying an unmet need in the analytics space. This opens up a large and growing market for VMware and we can expect significant revenues from this business in the near term.
The Bring Your Own Device Revolution
The bring-your-own-device (BYOD) revolution is being led by VMware with its View Mobile Secure Desktop. It provides a safe and secure environment for mobile virtualization by providing secure snapshots of the desktop which can be monitored and controlled by IT departments. It has an efficient hybrid storage mechanism which combines Flash and legacy storage to provide speed as well as cost efficiency.
VMware will partner with Nimble and deploy virtual mobile desktops that will enable employees to access company data securely through virtual snapshots, irrespective of the device used. Nimble uses an architecture called the Cache Accelerated Sequential Layout (CASL) that uses inline compression to compress virtual desktop data ~40 to ~50 percent without increasing its latency. The mobile desktop virtualization opportunity is a much bigger opportunity that desktops as it will cover smartphones and tablets which are growing at a much faster rate than PCs. As the workforce becomes more mobile and demands CRM and data services on the move, we expect this to become the biggest revenue driver for VMware.
EMC’s Leadership Can Help VMware Sales
EMC is the majority stake holder of VMware and is also the global leader in the enterprise storage system market as well as the storage software market. We believe enterprises moving to the cloud present a huge growth opportunity for storage and virtualization. EMC’s customers buying storage can also benefit from virtual desktops and resource pooling and this presents a cross selling opportunity for EMC to generate leads for VMware products.
Virtualization software is is the largest division of VMware and accounts for nearly 89% of VMwares value according to our analysis. We have a $112 Trefis price estimate for VMware, which is around 25% above the current market price.Notes: