How Has VMware Handled Operational Efficiency As It Has Matured?
VMware (NYSE:VMW) has come a long way in the last decade, from being a $600 million acquisition in 2003 to being currently valued at over $33 billion. Over the years, VMware has operated as a subsidiary of EMC (now owned by Dell) with the latter owning around 80% of VMware. The virtualization software market began expanding massively in late 2000s, with VMware as a market leader in the x86 server-based virtualization software market. Resulting revenues for the company ballooned from around $2 billion in 2009 to $6.6 billion in 2015 – a compound annual growth rate of almost 22%. This period has also been crucial for VMware transformation from a mid-cap company to a large-cap firm. In the same period, the total number of VMware employees increased from 6,700 at the beginning of 2009 to 19,000 at the end of 2015. [1]
As the company continues to mature, it has become important to manage its operating expenses to diminish the impact of revenue growth slowdowns (due to large base factor) on net cash profits. To quantify the operational efficiency of the company, the revenue generated per dollar spent on sales, general and administrative (SG&A) expenses can be regarded as a key indicator. In this article we take a look at how the company has handled the strong revenue growth, its operating expenses in order to make it more efficient in this period. We also take a look at our forecast for these metrics. We have a $76 price estimate for VMware’s stock, which is slightly lower than the current market price.
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How “Efficient” Has VMware Been?
VMware has generated roughly $3 per dollar spent on SG&A expenses from 2011 through 2015. This ratio declined slightly from $3 to $2.80 before recovering to $2.90 in 2015. Similarly, VMware’s adjusted gross profit per dollar of SG&A expenses stood at $2.60 in 2011, which dropped to $2.40 in 2014 before increasing to $2.50 in 2015. A key trend to note here is that 2015 was the first time in almost a decade that VMware’s revenue growth slowed down to single digits (just under 9%). VMware’s management mentioned that the company aims to improve its operational efficiency by reducing operating expenses and headcount. The company intends to reinvest its resources into fast-growing areas such as the network virtualization platfrom NSX, hyper-converged infrastructure solutions (vSAN), virtual storage and end-user computing and mobility solutions (AirWatch). [2]
It should be noted that the gross profit and SG&A figures are adjusted for depreciation, amortization, share-based compensation and other non-GAAP reconciliation measures reported by the company.
VMware’s business has gradually transformed from primarily a software licenses vendor (over half of net revenues from license agreements in 2009) to a services-based model with software licenses revenues falling to around 40% of net revenues in 2015. Since services are typically have lower gross margins than the licensing business, VMware’s gross profit margins have compressed almost 88% in 2011 to under 87% in 2015. This trend could continue in the coming years, with the company-wide adjusted gross margins falling to under 86% as shown below.
Going forward, the growth rate for revenues and gross profit is expected to slow down to mid single digits in the long run. We forecast VMware’s adjusted SG&A expenses to slow down further as the company matures. VMware’s SG&A expenses could grow at an even slower rate to compensate for relatively low revenue growth as shown below. As a result, the revenue generated per dollar spent on SG&A could improve slightly to over $3 in the coming years, according to our estimates. Additionally, the gross profit per unit SG&A could improve to $2.60 – a 10% improvement over 2014 levels as SG&A expenses to taper down. You can modify the interactive charts in this note to observe the impact a change in the Gross Margin and SG&A as a Percentage of Gross Profit can have on our price estimate for VMware.
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- VMware SEC Filings 10-K, SEC, January 2016 [↩]
- VMware Q4 2015 Earnings Call Transcript, Seeking Alpha, January 2016 [↩]