Virtualization giant VMware (NYSE:VMW) has witnessed massive growth in recent years, with its revenues growing from under $2 billion in 2009 to $6 billion in 2014. Back in 2003, EMC Corporation (NYSE:EMC) acquired VMware for $625 million,  while VMware is currently valued at over $33 billion. Massive growth in the virtualization industry started in the late 2000s with x86 server-based virtualization driving much of the growth. Over the last few years, VMware has expanded its offerings to include software-defined storage and network virtualization to add to its server virtualization capabilities.
We currently have an $86 price estimate for VMware’s stock, implying a market cap of about $36.5 billion. Our current price estimate is about 10% higher than the current market price. VMware’s stock price has fluctuated between $77 and $90 this year. Below we take a look at the factors driving the company’s future growth and why we remain bullish on VMware. We also take a look at some key challenges for VMware in the coming years that could potentially disrupt growth.
Areas of Growth for VMware
- Software-Defined Networking
The company launched the VMware NSX in late 2013, which merged its existing vCloud networking product line with the network virtualization platform of Nicira (which it acquired in 2012) into a single product family. The VMware NSX creates software-based network overlays on top of existing hardware, thereby decoupling networking-related intelligence from the hardware. This makes networks programmable and scalable, and gives enterprises the flexibility to implement technology changes through mere software upgrades. Comparatively, Cisco’s (NASDAQ:CSCO) approach to SDN is more hardware-centric, with the platform built on top of its Nexus switches which are controlled by application policy infrastructure controllers (APICs). As a result, the NSX platform is more appealing to enterprises since it allows them to put third-party software on cheap white-label networking hardware, making it potentially much cheaper to implement than installing Cisco’s hardware products that come with embedded software. According to IDC, more than 70% of large and mid-sized enterprises are likely to rework their networking setups over the next three years. VMware’s management mentioned that the company is witnessing strong momentum, which is likely to continue over the next few years. 
- Hybrid Cloud
VMware offers a common hybrid cloud platform for both on-premise private cloud deployment and on the public cloud. The company rebranded its hybrid cloud service to vCloud Air at the end of Q2 last year, after which VMware has witnessed massive growth in the hybrid cloud business. The hybrid cloud business grew by around 90% year-over-year through 2014, making it one of the fastest growing segments within VMware. As a result of its solid growth, hybrid cloud and software-as-a-service offerings combined formed about 5% of VMware’s net revenues through 2014, up from under 3% of net revenues in 2013. The vCloud Air platform supports over 5,000 applications from over 2,000 independent software vendors with apps ranging across various fields ranging from finance, healthcare, retail and telecom.  vCloud Air supports more than 90 operating systems, which is twice as many as competing platforms Microsoft Azure (NASDAQ:MSFT) and Amazon Web Services (NYSE:AMZN) combined. According to Research and Markets, the hybrid cloud market could grow at a CAGR of over 27% from $25 billion in 2014 to almost $85 billion through 2019.  Although near term growth in this segment could be hindered by a stronger dollar and tougher year-over-year comparisons this year, VMware is poised to capitalize on growth in this market.
- Converged Infrastructure
VMware’s hyper-converged infrastructure offering EVO:RAIL includes all aspects of compute, networking and storage on a unified platform. The EVO:RAIL appliance is a first of its kind in the industry, which simplifies the IT infrastructure of customers. It is a cost-effective solution to deploy VMware’s software-defined data center (SDDC) vision. In its early days, the company has witnessed a strong interest for EVO:RAIL across the U.S, Europe and Asia. The company expects EVO:RAIL to continue to gain traction through the year, with maximum growth expected in the latter half of the year. 
- End-User Computing
VMware has witnessed strong demand for its end-user computing and mobility solutions in the last few quarters since it acquired Airwatch for $1.5 billion last year. The trend was highlighted by a 50-60% year-over-year increase in end-user computing license bookings through 2014 and in Q1 this year. Keeping up the trend, the company witnessed a 30% year-over-year increase in license bookings in this domain through the June quarter. The growth rate was lower than previous quarters mainly due to tougher year-over-year comparisons. Within end-user computing, the desktop-as-a-service business grew by a healthy 15% on a y-o-y basis and the company gained share from competitors.  The recent addition of virtualization software for Windows 10 could help boost license revenues from both Mac and Windows users.
- Leader in Virtualization
The virtualization market grew in the last decade, predominantly due to the virtualization of x86 servers with VMware being a key player in the market. In the last few years, the industry has started shifting to desktop virtualization, often in conjunction with server virtualization. This makes it easy for clients to not only host their servers on the cloud, but also to run software and applications on virtual desktops, and also significantly cuts down hardware ownership and maintenance costs for clients. Desktop virtualization includes Virtual Desktop Infrastructure (VDI), Desktop Virtualization Servers and Hosted Virtual Desktop. Currently, VDI or Desktop-as-a-Service (DaaS) is the largest segment within desktop virtualization, with VM Horizon suite being the dominant player in the market along with Citrix XenDesktop and Microsoft. In a recent report, IDC named VMware as a market leader in terms of capabilities of the product offered. 
Key Challenge for VMware: Docker Containers vs Virtual Machines
Docker is an open-source project that deploys software applications within containers by adding a layer of operating system virtualization that sits on top of Linux, Windows or Mac OS. Docker has gained popularity since its inception in 2013, as IT organizations and developers use it as a portable platform for delivering applications across operating systems. Moreover, containers use far less system resources than entire virtual machines on a virtualization platform, due to which the Docker 1.0 has become popular.  The Docker platform uses containers that use shared operating systems and sit on top of single Linux instances, thereby making them more efficient to use than virtual machines (VM) offered by virtualization providers such as VMware or Citrix.
The Docker Hub – an online repository – has already provided over 300 million containers to developers, and will soon add another 100 million containers for third-party downloads.  Although this technology could appear to be threatening to VMware’s business, management indicated that it will work with Docker, in addition to Google (NASDAQ:GOOG) and Pivotal (partially owned by VMware), to integrate Docker containers on its virtualization platform.  The result could be VMware releasing its own containers, compatible on its platform in addition to the existing virtual machine (VM) architecture.
More recently, VMware announced the release of two open-source software suites to allow Docker containers to be deployed on the VMware ecosystem. The two software packages are called Project Photon that is designed to run a bare VM hypervisor on Linux to run containers and and Project Lightwave that is an access management software suite to control containers.  The company intends to roll out these projects to the public and get feedback to help it integrate containers on its platform better.
VMware has reported strong results in both Q1 and Q2 this year despite a slowdown in the software licenses business. Services revenues have driven much of the growth for VMware. With the key growth areas expected to continue to boost top line figures for VMware in the coming quarters, we believe that the company is poised to capitalize on the shifting market trends. We currently forecast the company’s services revenues to drive results in the coming years, with maintenance revenues as a percentage of license revenues rising from 117% in 2014 to almost 130% through the end of our forecast period.Notes:
- EMC Completes Acquisition of VMware, VMware Press Release, January 2014 [↩]
- VMware Q1 2015 Earnings Call Transcript, Seeking Alpha, April 2015 [↩]
- What is vCloud Air?, VMware Product Description, September 2015 [↩]
- Global Hybrid Cloud Market 2015-2019, PR Newswire, April 2015 [↩]
- VMware Q1 2015 Earnings Call Transcript, Seeking Alpha, April 2015 [↩]
- VMware Q2 2015 Earnings Call Transcript, Seeking Alpha, July 2015 [↩]
- VMware Named A Leader in the IDC MarketScape for Client Computing Software, VMware Blog, June 2015 [↩]
- What is Docker and why is it so darn popular?, ZD Net, August 2014 [↩]
- Docker update speeds and organizes container deployments, PC World, April 2015 [↩]
- VMware Teams With Docker, Google and Pivotal to Simplify Enterprise Adoption of Containers, VMware Press Release, August 2014 [↩]
- VMware preps its virtualization stack for Docker, Computer World, April 2015 [↩]