VMware (NYSE:VMW) announced its Q1 earnings on Tuesday evening, reporting a 13% year-over-year (y-o-y) growth in its revenues on the back of growing virtualization and cloud computing demand.  Established software including vSphere continued to exhibit decent growth during the quarter. Further, the company’s recently launched vCloud suite gained strong traction. Total revenues for the first quarter were $1.19 billion, of which services revenues constituted $605 million, up 23% on a y-o-y basis. Revenues from enterprise license revenues were up a modest 1.3% to $488 million. 
While the business environment has weakened in the U.S. in the last couple of months, revenues from the country still grew by 17%. However, international market growth was relatively slower at 9% due to persistent weakness in European markets. Core operating margins (excluding one time items) remained stable as non-GAAP operating profit was $388 million, an increase of 13% on a y-o-y basis. 
However, what came as a concern for the market was lower than expected Q2 guidance. The company has given guidance for Q2 revenues in the range of $1.21 to $1.24 billion, which was slightly below market expectations.  This was, however, mainly due to adjustments related to Pivotal, a joint venture between EMC and VMware.
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Pivotal has started working as an independent entity from April 1. Therefore, all revenues and costs associated with VMware’s contribution to Pivotal will be excluded from its financial statements from Q2 onwards. VMware estimated approximately $110 million of Pivotal-related revenues associated with Q2 through Q4 2013.  However, we think markets may have overreacted to the Q2 guidance.
Below we take a detailed look at Pivotal and key growth drivers for VMware.
Pivotal Initiative Provides New Growth Opportunities
In an attempt to gain a share of the $2 billion and rapidly growing hosted web services market, EMC and VMware formed Pivotal, a joint venture led by Paul Maritz, Chief Strategy Officer of EMC. This market is currently dominated by Amazon (NASDAQ:AMZN) with its Amazon Web Services and Microsoft‘s (NASDAQ:MSFT) Azure Cloud and Google’s Cloud Platfrom.
EMC and VMware have committed significant resources to focus on Big Data and Cloud Application Platforms. Approximately 500 VMware employees are being transferred to Pivotal.  The move 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 and up to $1 billion by 2017.  Pivotal also recently got a $105 million investment by GE for a 10% stake, which implies the venture is already being valued at over $1 billion. 
Software Defined Datacenters Key To Virtualization
Software-defined data centers are a key innovation in the virtualization space as it provides a solution to support both enterprise applications and new cloud services. VMware acquired companies such as Nicira and DynamicOps in the second half of 2012 to make strides in the software-defined data center space. These companies use software to abstract hardware resources and pool it into aggregate capacity, which can be used efficiently as needed. Customers gained through these acquisitions include AT&T, DreamHost, eBay, Fidelity Investments, NTT and Rackspace.
During Q1 earnings, VMware announced its intention to create a new product line called VMware NSX.  The platform will merge VMware’s vCloud networking product line with Nicira’s network virtualization platform into a single product family. With new innovative products like NSX, we can expect continued growth in VMware’s revenue going forward.
Big Data Analytics, Mobile Visualization Offerings To Drive Growth
VMware is making efforts to tap the big data analytics space with the acquisition of Cetas. Big data analytics is currently used for processing massive amounts of data and costs dearly in deployment and maintenance. 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 help VMware meet an an unmet demand from small and medium enterprises, in the analytics space.
Further,VMware has partnered with Nimble to deploy virtual mobile desktops that will enable employees to access company data securely through virtual snapshots, irrespective of the device used. The mobile desktop virtualization opportunity is a much bigger opportunity that desktops as it covers 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.
We are updating our $101 Trefis price estimate for VMware to reflect the earnings.Notes:
- VMware reports first quarter 2013 results, VMware, April 23 2013 [↩] [↩] [↩]
- VMware’s CEO Discusses Q1 2013 Results – Earnings Call Transcript, Seeking Alpha, April 23 2013 [↩] [↩] [↩] [↩]
- EMC, VMware To Launch Pivotal Initiative As Separate $300M Firm, CRN, March 13 2013 [↩]
- GE invests $105M in Pivotal to build the Industrial Internet, Venture Beat, April 24 2013 [↩]