VMware’s Stock Looks Undervalued Given Strong Revenue Growth From Hybrid Cloud Offerings

by Trefis Team
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VMware’s (NYSE: VMW) stock has fallen from above $200 a couple of months ago to around $150 now despite lack of credible weakness in demand or performance. While part of the decline can be attributed to weaker market sentiment, another reason could be the impression among investors that VMware’s guidance is too aggressive. After all, the guidance depends considerably on how successful the company is at extracting synergies from acquisitions. Trefis highlights trends in VMware’s revenues over recent years along with our forecast for 2020 and 2021 in an interactive dashboard, and we believe that investors are underestimating the company’s strength in the hybrid cloud segment. While VMware’s earnings for the most recent quarter came in below expectations, we maintain a fair value of  $183 for VMware’s stock. Additionally, you will find more Trefis information technology data here.

An Overview of VMware’s Business Model

  • VMware makes money from the sale of software and services for data center management, hybrid cloud computing, remote access and desktop virtualization.
  • Simply put VMware’s products increase the efficiency of compute and storage hardware by servicing multiple users through software. While each user gets the benefit of a full system, the underlying hardware could be shared among many users.
  •  This approach of abstracting physical hardware to make multiple logical copies has the benefit of reducing cost and complexity associated with managing distributed systems.
  • As the market has evolved, VMware has also been getting into hybrid cloud software or software, that helps tie different clouds together.
  • Another area of focus has been moving away from virtual machines into containers – a less resource-intensive alternative to virtual machines.

What Are The Alternatives?

  • Due to the nature of the virtualization, hybrid cloud and the data center markets, VMware’s offerings extend across compute, storage and networking.
  • The alternatives thus include Red Hat, Nutanix, HPE, Cisco and also major public cloud companies.

Understanding Trends In VMware’s revenues

VMware’s 2 divisions (1) Software License, and (2) Maintenance and Professional Services, are expected to contribute roughly $4.2 billion (43%) and $5.8 billion (57%) to its Total Revenue estimate of $10.1 billion for full-year 2020

  • 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.

[A] Software License Revenue growth of about a billion dollars over the next two years will be be driven by growing hybrid cloud adoption and the company’s cloud partnerships

  • Software License revenue increased by $588 million last year.
  • Over the next couple of years, growth in hybrid cloud and especially the partnership with Amazon, is likely to drive growth of $963 million.

[B] Maintenance and Professional Services to grow by about $1.2 billion over the next two years due to growth in multi-cloud deployments and the associated services

  • Last year, the $524 million increase in revenue has been driven by incremental adoption of the company’s solution deployments.
  • Over the next couple of years, the incremental $1.2 billion is likely to be derived from the growth in multi-cloud deployments and the associated services.

We forecast VMware’s EPS figure for full-year 2020 to be $5.66. Taken together with our forward P/E multiple of 32.3x for the company, this works out to a price estimate of $183 for the company’s stock, which is roughly 20% ahead of the current market price.

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