VMware’s Q1 Momentum Likely To Continue On The Back Of Strength In Subscription Business And Partnerships

by Trefis Team
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VMware (NYSE:VMW) reported its fiscal Q1 2020 results late last week. The company beat consensus expectations on revenue and earnings and reaffirmed its guidance for the year. VMware’s strong showing stemmed from the momentum in the hybrid cloud and SAAS business, which was up 35% y-o-y and represented over 12% of Q1 revenues. The company’s revenue growth can also be attributed to VMware’s three-tier system of consumption for the VMware Cloud Foundation. Customers have the option of running it on their own, through VMware’s 4,000 partners (including IBM and Microsoft) or directly through VMware thanks to the company’s partnership with Amazon and Dell. In addition to providing a choice to the customers, this arrangement balances partner expectation while expanding VMware’s reach.

With VMware’s revenues trending strongly higher on the back of increased product demand and reach, we have revised our fair value estimate to $182 per share from $164 per share. Our interactive dashboard on VMware’s Q1 Performance outlines our forecasts and estimates for the company. You can modify any of the key drivers to visualize the impact of changes on its valuation. Also, you can see more Trefis technology company data here.

A Quick Look At VMware’s Revenue Sources

VMware makes money from the sale of software and services for data center management, hybrid cloud computing, remote access and desktop virtualization. The company’s fiscal year ends on the Friday nearest to January 31 of each year.

VMware reports its revenue ($9 billion in Fiscal 2019) in two segments:

  • Software License (2019 revenue of $3.8 billion, 42% of total revenue): Segment revenue is derived from the sale of licenses and subscription for the company’s products.
  • Maintenance and Professional Services (2019 revenue of $5.2 billion, 58% of total revenue): Segment revenue is derived from software maintenance and support, professional services and an allocated portion of subscription revenue.

Revenue trends over recent quarters, Q1 performance and and full-year 2020 expectations

  • Software License revenue grew by $95 million to $869 million (+12.3% y-o-y). We expect revenue to grow by $492 million to $4.3 billion (+13% y-o-y) in 2020.
  • Maintenance and Professional Services revenue grew by $163 million to $1.4 billion (+13.2% y-o-y). We expect revenue to grow by $600 million to $5.8 billion (+11.6% y-o-y) in 2020.
  • Total revenue grew by $258 million to $2.3 billion (+12.8% y-o-y). We expect revenue to grow by $1.1 billion to $10 billion (+12.2% y-o-y) in 2020.
  • Despite beating consensus estimates comfortably, VMware’s guidance for Q2 remains unchanged – possibly due to management concerns around the broader macro-economic weakness.
  • We also derive confidence in VMware’s sustained performance from the growing spread between billings and revenue. This spread has been driven by the SAAS business, which the company expects to continues. SAAS billings convert into revenue slower than on-premise product bookings, since SAAS revenues are distributed over the contract period versus on-premise product revenue, a majority of which gets recognized upfront. A growing SAAS book is likely to translate into fatter subscription tails for the company’s revenue.
  • Lastly we note, that VMware in currently in the FedRAMP approval process to get the authority to operate (ATO) in government setups. Considering that Amazon and Microsoft are the only two players remaining in the race for the prestigious $10 billion JEDI contract to be awarded by the Department of Defense, VMware appears well positioned to be a definite gainer irrespective of whether Microsoft or Amazon bags the contract – given its deep relationships with both these technology giants.

We forecast VMware’s EPS figure for full-year 2020 to be $5.66. Taken together with our forward P/E multiple of 32x for the company, this works out to a $182 per share price estimate for the company’s stock, which is slightly ahead of the current market price.

Do not agree with our forecast? Create your own price forecast for VMware by changing the base inputs (blue dots) on our interactive dashboard.

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