VMware Earnings Preview: Updates On Growth Drivers Needed

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VMware (NYSE:VMW), the leading desktop virtualization company, is set to announce its Q2 earnings on July 23. Revenue growth is expected to come under pressure from its past double-digit levels. While the company has given guidance for Q2 revenues in the range of $1.21 to $1.24 billion, a double-digit growth on a yearly basis, there are indications that it could miss estimates. During its capital allocation conference call, VMware’s parent company EMC presented lower operating cash flows ($1.87 billion) from VMware in 2013 than what it generated in 2012 ($1.9 billion). [1]

This data could be a sign of a further slowdown in growth and/or pressure on operating margins, which would lead us to lower our estimates. While services revenues are expected to see double digit growth, we will keep a close eye on enterprise license revenues, which we expect to remain dull in Q2. Geographically, we expect the U.S. to remain the lead growth driver despite federal sequestration while international markets, particularly Europe, will see growth slowing down.

In Q1, at $1.3 billion, VMware reported a 13% y-o-y revenue growth. 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. Below we take a look at key trends affecting VMware.

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See our full analysis on VMware

Virtualization Market Maturing

According to the latest Gartner report, close to two-thirds of x86 server workloads are now virtualized, trimming the growth opportunities for VMware, which remains the largest player in the market. [2] Furthermore, competition from Microsoft and Citrix is also threatening VMware’s market share in a more mature market. We, therefore, don’t expect a major growth in enterprise license revenues. However, we expect VMware’s services revenue, including existing license maintenance fees, to continue to grow at a decent rate. This is due to VMware’s large installed base. We will keep a close watch on unearned revenue, which represents advance bookings for multi-year license agreements or maintenance agreements. A slowdown here would indicate that more customers are migrating to competing products.

Further, we will also keep a close tab on updates on VMware’s efforts to drive growth in the mobile virtualization market. The mobile desktop virtualization opportunity is a much bigger opportunity than desktops as it covers smartphones and tablets, which are growing at a much faster rate than PCs. VMware has earlier partnered with Nimble to deploy virtual mobile desktops that enables employees to access company data securely through virtual snapshots, irrespective of the device used. 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 going forward.

Eyes On Software Defined Datacenters And Cloud Efforts

Increasing mobile computing and the bring your own device (BYOD) movement have led to a surge in data traffic. This has been putting significant pressure on traditional data centers due to the inefficient capacity use of switches (which connect storage hardware with the network through cables). Further, due to the lack of cross-compatibility with products from other vendors, enterprises have to stick to their original vendors and buy expensive switches, which in turn translates to higher costs. However, with cost-cutting taking priority for many enterprises, software defined networking (SDN) is gaining traction. VMware has acquired a number of companies including Nicira and DynamicOps in later half of 2012 to gain entry 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.

We will keep a watch on VMware’s progress on its 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. We will also look for more updates on Pivotal, a joint venture of EMC and VMware (a subsidiary of EMC). The JV started its operations on April 1, 2013 and is expected to garner almost $300 million in revenues in 2013 and up to $1 billion by 2017. [3] Through Pivotal, EMC and VMware are aiming to focus on Big Data and Cloud application platforms. IDC cloud research shows that revenue from IT cloud services is expected to reach $72.9 billion in 2015 at a compounded annual growth rate (CAGR) of 27%. [4]

We currently have a $100 Trefis price estimate for VMware, which is nearly 40% above the current market price. We will update our price estimate post earnings.

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Notes:
  1. EMC Capital Allocation Conference Call, EMC, May 30 2013 []
  2. Magic Quadrant for x86 Server Virtualization Infrastructure, Gartner, June 27 2013 []
  3. EMC, VMware To Launch Pivotal Initiative As Separate $300M Firm, CRN, March 13 2013 []
  4. IDC Cloud Research, IDC []