Can Recent Developments Harm VMware In The Long Run?

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VMware (NYSE:VMW) has had an eventful month with two major developments that could possibly impact the company in the near term. Firstly, the U.S. Defense Information Security Agency (DISA) reversed a $1.6 billion multi-year agreement with VMware after rival companies including Amazon (NASDAQ:AMZN) and Citrix Systems (NASDAQ:CTXS) filed protests against the government for being left out of the bidding process. [1] Second, VMware was sued by a Linux kernel developer in Germany for violating the GPL2 compliance requirements over using the Linux kernel source code in the VMware ESXi hypervisor products. [2] VMware’s stock price fell by almost 7% in the first half of March before recovering slightly to present levels.

We maintain our $90 price estimate for VMware, which is slightly higher than the current market price.

See our complete analysis for VMware here

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VMware’s Agreement With The Government

According to latest news reports, Amazon, Citrix, Nutanix and Minburn Technology filed a protest with the U.S. Government Accountability Office (GAO) stating that they were not presented with an equal opportunity to bid for the enterprise license agreement. [3] In its Q4 earnings call, VMware management mentioned that they were very close to signing this mammoth deal with the DISA, which would include branches of the military such as the Army, the Navy and the Air Force. [4] However, in a recent development, the GAO released a document titled “A Justification For Other Than Full And Equal Open Competition”, effectively rejecting the aforementioned protests. The reasons behind “routine” protest rejections are not made public by the accountability office, due to which the details about the rejection are not in public domain.

However, it is known that VMware software has been implemented at the Department of Defense for over eleven years and is integrated with all internal systems. From a cost-perspective it makes sense for DoD to maintain status quo and continue with VMware implementation. According to the released document, it would be difficult to transition the software support and services offered by VMware for existing licenses to other interested parties under the current framework. [5]

Violating GPL Compliance For Linux Developers

According to linux kernal developer Christoph Hellwig and the advocacy group Software Freedom Conservancy, VMware allegedly violated the General Public License (GPL) compliance requirements in its products. [6] The allegation includes the use of the code that Hellwig wrote for the Linux kernel in VMware’s ESXi hypervisor products. Hellwig, who holds copyrights on certain parts of the Linux kernel source code, believes that VMware’s source code for its ESXi line of products contains portions of the Linux kernel code, yet has not made it public as required by the GPL version 2. [7] The case was filed in Hamburg, Germany. Back in 2007 when VMware had its IPO, similar questions were raised by Linux developers and third-parties mentioning that VMware’s ESX server was too close to the open-source Linux operating system, which makes it illegal to sell that as proprietary software. [8]

VMware management has responded to such claims as meritless and the company would have preferred to resolve to the issue outside of court. Moreover, the company has defended its stance by stating that the core of the ESXi operating system VMware’s vmkernel controls resources. When third-party drivers interact with the interface they may or may not use Linux drivers. In case they do, the kernel that comes into operation is called vmklinux for which the source code is publicly available in compliance with the GPL. [9] Accordingly, the company has no plans to restrict distribution or sale of its proprietary-licensed works.

Positive Outlook For The Year

These developments may have had a short-term impact on investor sentiment, but as things stand VMware seems to be on course to get the DISA contract and defend its stance on the Linux case. The company has long been a supporter of the open-source software community and has actively been a part of OpenStack, the open-source cloud computing software platform.

The company reported a 16% annual rise in net revenues for 2014 to just over $6 billion. [4] VMware has not made any revisions to its prior revenue guidance for the year, which stands at about $6.7 billion for the full year. We expect the company to witness a 10-12% growth in net revenues for 2015, in line with the company’s most recent guidance. Services revenues are likely to grow by about 8% over the previous year levels while license revenues could grow by up to 8% for the full year. The company further plans to repurchase shares worth $1 billion through 2015 – up from $700 million in 2014.

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Notes:
  1. VMware mysteriously loses $1.6B government contract, Channelnomics, March 2015 []
  2. VMware sued for failure to comply with Linux license, ZD Net, March 2015 []
  3. US military CANCELS US$1.6 BEEELLION VMware deal, The Register, March 2015 []
  4. VMware Q4 2014 Earnings Call Transcript, Seeking Alpha, January 2015 [] []
  5. DISA cancels $1.6B VMWare contract, C4ISR & Networks, March 2015 []
  6. VMware sued, accused of ripping off Linux kernel source code, The Register, March 2015 []
  7. VMware sued for alleged GPL license infractions, PC World, March 2015 []
  8. Is VMware too close to Linux?, The Register, August 2007 []
  9. VMware wants amicable end to ‘meritless’ Linux-lifting lawsuit, The Register, March 2015 []