VMware Shareholders Unhappy With Virtustream Cloud Joint Venture With EMC

-2.08%
Downside
142
Market
140
Trefis
VMW: VMware logo
VMW
VMware

VMware’s (NYSE:VMW) stock has plummeted by about 25% in over a month following the announcement of the Dell-EMC deal. There have been a few points of concern for VMware’s shareholders since the deal was announced. EMC initially had an 80% stake in VMware, with 97% of voting rights. With Dell acquiring EMC (NYSE:EMC), it has effectively taken the 97% voting rights but floated over 50% of VMware’s stock as “tracking stock” with no voting rights. Under the conditions of the deal, Dell would have a 28% stake in VMware with 97% voting rights, while existing VMware shareholders retain the 20% ownership with 3% voting rights, and over 50% ownership lies with former EMC shareholders in the form of tracking stock and no voting rights. [1]

Moreover, Dell faces a massive debt of about $60 billion, with almost $50 billion added due to the EMC acquisition. [2] However, VMware’s management reassured shareholders that VMware’s cash flows or debt capacity will not be used to finance the transaction. [3] After the Dell-EMC deal was announced, EMC released a statement announcing its intention to partner with VMware on a joint venture for a new hybrid cloud service business that uses capabilities of its recent acquisition Virtustream. [4] In a recent development, some of VMware’s institutional shareholders have demanded that VMware pull out of the joint venture mainly because Virtustream’s global expansion efforts in 2016 could drag down VMware’s earnings. In addition to expected operating losses for Virtustream, VMware announced that it expects CapEx to rise to over $620 million for 2016, up from about $350 million expected through 2015. [3] Below we take a look at VMware’s hybrid cloud business and how the joint venture might impact VMware.

See our complete analysis for VMware here

Relevant Articles
  1. Company Of The Day: VMWare
  2. Is VMware Stock A Good Bet At $100?
  3. Forecast Of The Day: VMware’s Maintenance and Service Revenue
  4. Does VMware’s Stock Have An Upside Potential?
  5. What To Expect From VMware’s Stock With Results Near?
  6. Company Of The Day: VMware

EMC’s $1.2 Billion Acquisition – Virtustream

EMC announced the acquisition of cloud computing management software and infrastructure-as-a-service (IaaS) provider Virtustream for $1.2 billion in an all-cash deal in May this year. [5] EMC previously acquired three companies in late 2014 to boost its presence in the cloud computing market space, including enterprise-grade hybrid cloud solutions platform Cloudscaling, cloud technology provider Maginatics, and subscription-based cloud backup and recovery platform Spanning. [6] EMC’s initial idea was to operate Virtustream within EMC’s Federation Enterprise Hybrid Cloud model, wherein all acquired companies either operate as separate entities or under various divisions within the parent company.

How Virtustream Links With VMware’s vCloud Air

EMC’s hybrid cloud platform, which works with VMware’s hybrid cloud service (rebranded as VMware vCloud Air last year), can be bundled with Virtustream’s software. At the time of the acquisition, VMware’s management reflected a similar idea in a released statement. According to management, Virtustream’s IaaS and private cloud software xStream can be bundled with VMware’s vCloud Air public cloud infrastructure and private cloud software, respectively. More recently, VMware’s management reiterated the idea of creating new hybrid cloud offerings for enterprise customers using Virtustream and the capabilities of both VMware and EMC. [7] The combined project was to involve EMC’s Cloud Managed Service and Storage Management services and VMware’s vCloud Air Infrastructure-as-a-Service (IaaS) business with Virtustream’s IaaS offerings.

The combined hybrid cloud offering would have had EMC’s expertise in managing storage and cloud, while VMware’s virtualization capabilities provide the link between public cloud (typically handled by a third party) and on-premise private cloud deployment. Accordingly, Virtustream’s contribution to the project was to provide its software – such as xStream or Viewtrust – to deploy hybrid cloud in a manner that would allow even those apps to run that are not designed for a hybrid cloud, giving customers flexibility to scale up and grow. [8] Moreover, the idea of combining Virtustream’s IaaS with VMware’s virtualization theoretically works well with VMware’s focus on dockers and containers instead of just offering virtual machines. EMC announced that both VMware and EMC will be 50-50 partners in this new joint venture. [4]

Shareholders React To Joint Venture

VMware’s management indicated that Virtustream is expected to incur operating losses in the range of $200-300 million through 2016 as it expands its global operations. [9] VMware shareholders have not been very comfortable with the idea of the joint venture with EMC, as many of them expect Virtustream to weigh down VMware’s earnings. Re/code reported a list of three demands from various institutional shareholders to help VMware after EMC’s acquisition. One of these demands includes scrapping the idea of VMware bearing the burden to help expand Virtustream. [10] Subsequently, Reuters reported that EMC will retain a majority stake in Virtustream, with VMware keeping an uncertain minority stake. [9] The other major demands from the institutional shareholders include a share buyback program of about $3 billion and improved voting rights for VMware shareholders, with lesser rights for owners of the tracking stock.

VMware’s Hybrid Cloud Business And Outlook

In the most recent quarter, VMware announced the general availability of new hybrid networking capabilities, including VMware Hybrid Cloud manager and Advanced Networking Services. VMware realized a 50% year-over-year growth in hybrid cloud and Software-as-a-Service revenues to just over $100 million through the September quarter. According to the company’s estimates, hybrid cloud and SaaS combined contributed over 6% of VMware’s net revenues through the first three quarters of 2015, up from 5% in 2014 and under 3% of net revenues in 2013. After announcing the hybrid cloud service in the Asia-Pacific region last quarter, the company announced the addition of three new service locations in the U.S. The three service locations in Texas, New Jersey and Virginia are expected to be functional in the current quarter. [11]

The company reported solid growth in the most recent quarter, with a 10% annual growth in net revenues to $1.67 billion. [11] The company expects the strong momentum for hybrid cloud services to continue over the coming quarters. Going forward, management expects Q4 revenues to be 8-9% higher than prior year levels at about $1.85 billion. VMware’s services revenue stream is likely to continue to witness a higher growth rate than the revenues generated through license bookings. The company has given guidance for license booking revenues to rise by 4-5% on a year-over-year basis to about $815 million, while services revenues could rise by over 10%.

If VMware continues to be part of the Virtustream joint venture, the company would have to incur heavy initial investment in terms of both operating and capital expenditures. In addition to a $200-300 million of operating losses, VMware’s CapEx could shoot up to $620 million, up from about $350 million expected through 2015. However, the JV could add a “few hundred million dollars” to its top line next year, with an expected double-digit growth rate. Although Virtustream’s converged solutions could be the next big thing in hybrid clouds, it would put some near-term pressure on VMware’s financials.

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

Notes:
  1. Dell Will Issue a Lot of Not-Quite-Stock to Pay for EMC, Bloomberg View, October 2015 []
  2. Dell Faces $60 Billion in Total Debt With EMC Deal, Bloomberg, October 2015 []
  3. VMware Q3 2015 Earnings Call Transcript, Seeking Alpha, October 2015 [] []
  4. EMC and VMware Reveal New Cloud Services Business, EMC Press Release, October 2015 [] []
  5. EMC To Acquire Virtustream, EMC Press Release, May 2015 []
  6. EMC Scores a Cloud Hat-trick; Acquires Cloudscaling, Maginatics and Spanning, EMC Press Release, October 2014 []
  7. A Global Cloud Network Powered by VMware, VMware Radius, October 2015 []
  8. EMC and VMware regroup as Virtustream for hybrid cloud, InfoWorld, October 2015 []
  9. Exclusive: EMC to keep majority stake in Virtustream – sources, Reuters, November 2015 [] []
  10. EMC and VMware Shareholders Demand Changes to Dell Buyout Deal, Re/code, November 2015 []
  11. VMware Reports Third Quarter 2015 Results, VMware Press Release, October 2015 [] []