VMware’s Hybrid Clouds, Software-Defined Storage And Network Virtualization Key In 2014, Stock Worth $95

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VMware (NYSE:VMW) reported a solid set of results for Q1 2014 on April 22, reporting year-over-year (y-o-y) growth in both revenue streams – product license revenues (up 15%) and services revenues (up 14%). The company’s software license gross margins have consistently improved over the last few years, from 87.7% in 2009 to over 90% in 2013. Continuing the trend, the gross margins for software licenses grew to over 91% for Q1 2014 – in line with the company’s expectations. Going forward, VMware expects its margins to remain at Q1 levels for the full year. [1]

Software-defined data centers (SDDC), the vCloud Hybrid suite and end-user computing remained VMware’s three main areas of focus. Network virtualization (also called software-defined networking) and software-defined storage both form an integral part of the company-defined SDDC vision. Both VMware NSX, the network virtualization platform, and the newly launched Virtual SAN (vSAN) software-defined storage platform saw positive customer response during the first quarter. Although these markets are still in nascent stages, the company expects future earnings to be driven by network virtualization and software-defined storage.

We have a revised $95 price estimate for VMware’s stock, which is slightly higher than the current market price.

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See our complete analysis for VMware here

Storage And Networking Virtualization Further The Software-Defined Data Center Vision

VMware’s network virtualization platform, the NSX, started gaining traction during the first quarter. The company attributed much of the growth to its new approach in dealing with security on VMware NSX, wherein the network security features are integrated with the product. This has enabled the security features to be intelligence driven and automated rather than “bolted on”. However, the technology is likely to become more popular in the long run and the company expects more meaningful contribution from network virtualization in the coming quarters.

VMware’s Virtual SAN (vSAN) storage platform was launched for general availability late in the quarter, and was available for selling for only 14 days in Q1. However, in those few days, the company saw a good customer response for the product. Given that vSAN is VMware’s first software-defined storage product and that the market is still in early stages, it is likely that it takes time for vSAN to contribute significantly to VMware’s revenues. Additionally, the company saw a strong customer response for vSAN and has already closed a few major deals with large-enterprise customers for the next quarter. Going forward, the expect the adoption of software-defined storage to grow among large enterprises, which are increasingly realizing the benefits of software-defined data centers.

Non-vSphere vCloud, End-User Computing Products Increase Revenue Contribution

In February, VMware launched Horizon 6, its Desktop-as-a-Service (DaaS) for enterprise class virtual desktops which run on VMware’s vCloud hybrid service. The company mentioned that it gained market share in the desktop virtualization arena but did not provide any figures. More recently, the company announced the availability of Horizon 6 integrated with vSAN and cloud management products. Furthermore, the company acquired AirWatch for $1.5 billion at the beginning of the quarter to enhance its end-user computing capabilities, but its licenses and services combined contributed only about $5 million to VMware’s net revenues. However, the company expects the contribution from AirWatch to be around $100 million by the end of the year.

The company faced a declining contribution from its core vSphere hypervisor product bookings during 2013. Although VMware enhanced the basic product and offered vSphere with Operations Management (vSOM) in early 2013 to help customers manage their virtualization environments better, the company has witnessed an increasing contribution from newer products that are gaining popularity among customers. In 2013, the company witnessed a sequential increase in the revenue contribution of non-standalone vSphere licenses from 30% in Q1 2013 to about 40% in December quarter. The mix of these licenses further increased to 45% in Q1 2014. Going forward, integrated products such as vSAN, NSX and Horizon are likely to continue increasing.

VMware has maintained its revenue guidance for the full year of $5.9-$6.1 billion, a 15% increase from 2013. If the company’s performance for the full year remains similar to the Q1 performance, it is likely to meet the expected guidance. Given the trend shift in the market towards adopting the SDDC vision, newer products such as vSAN, Horizon 6 and the NSX are likely to drive VMware’s performance in the coming years.

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Notes:
  1. VMware Q1 2014 Earnings Call Transcript, Seeking Alpha, April 2014 []