For the First Time, VMware Takes a Shot

Virtualization giant VMware, whose stock value was reeling following a whopping drop from $83 to $60.73 per share in after-hours trading Jan. 28, lost about 27 percent of its paper value – or about $8 billion – in a matter of hours because it reported fourth-quarter revenues that fell short of Wall Street expectations. VMware also forecast 2008 revenue growth of 50 percent, compared to 88 percent in 2007.

In response to the VMware slide, its parent company, EMC, saw its own stock dip 11.5 percent.
VMware, whose hypervisor technology is now in about 80 percent of all enterprise IT systems, according to Gartner, IDC and ESG research, has seen its fortunes climb rapidly for most of this decade. VMware, acquired by EMC in 2003 for $625 million, has been a true success story in IT.

Its virtualization platform has made IT systems more efficient and enabled them to use much less electrical power. Its products work with virtually every IT company and it has enriched its shareholders with handsome profits.

Given that, the abuse it took Jan. 28 from investors at the New York Stock Exchange was unusual.

So why did it happen? Were the disappointing revenue numbers bound to happen at some point? Was it over-hyped by its parent company, EMC, and by analysts and the IT media? Or was this a mere blip on the radar screen that can be traced to other conditions?

Resource Library:

One analyst, Trip Chowdhry at Global Equities Research, told Reuters that VMware's stock – which had quadrupled in value since its August 2007 IPO – was "overhyped."

"If you miss your numbers in just your second quarter after going public, that suggests the stock was overhyped," Chowdhry said. "The story is not as perfect as investors believe. Oracle and Microsoft and Citrix [which have all entered the virtualization sector in recent months] have spoiled VMware's party. Not only that, VMware's execution has been flawed.”

Others aren’t so sure.

VMware officials said net profit in the fourth quarter was $78 million, or 19 cents per share, compared to $31 million, or 9 cents per share, a year earlier. Revenue rose a very respectable 80 percent to $412 million, but it missed Wall Street's average target of $417 million, according to Reuters Estimates.

Mark Bowker, an analyst with Enterprise Strategy Group, told eWEEK that the timing was particularly unlucky for the quarterly VMware earnings call.
 
"The VMware earnings call was one of brutal timing," Bowker said. "First, all of Wall Street is walking on egg shells because of the uncertainty of the U.S. economy. Any bad news from any respectable company in any industry is putting stocks on a roller coaster. 

"Second, VMware announced earnings one week after Microsoft announced its formal entrance into the server virtualization market. They hadn't even dialed the [conference] call number, and they were swimming with piranhas," Bowker said. 

In addition, he said, it’s important to split VMware (the company and its products) from the stock price.

"Investors are puzzled at how a company that grows its top line 88 percent in 2007 and only project 50 percent expansion in 2008," Bowker said. "Thus, the haircut in market capitalization. VMware the company will face more competition from the likes of Microsoft and Citrix, but its products are solid. Our research shows that 81 percent of organizations use server virtualization in production environment to some degree, and 46 percent consider themselves to be running 'Tier 1' applications on virtual servers. Most of these are VMware shops. Customers are betting on VMware being a critical part of their IT infrastructures." 

It is true that VMware the company has to prove it's not a one-hit wonder, he said, "but then again, no other software company in history has grown this fast, so there are likely to be some scale-out challenges."

"Think about facing these challenges when the economy is harder to read than a par putt on hole No. 18 at Pebble Beach with the world watching," Bowker said.

Charles King, an analyst with Pund-IT Research, told eWEEK that he doesn’t "see that this stock or the company has been over-hyped."

"They took a pretty conservative line on what their earnings would be in 2008, for one thing," King said. "This company has done something really interesting in the annals of technology ideas, and they're a very, very profitable company. Look back to the '90s and you remember many companies that were rated five, 10, 15 times their value and never put any black ink on their balance sheet at all."

Fundamentally, the company has some new challenges, but is in excellent shape, with great technologies and an all-star list of enterprise clients, King said. "Right now, they're the game in town to beat," he said.

Because of its success, VMware has become a "bellwether, the market leader in virtualization, so they're going to get more scrutiny," King said. Like a quarterback in football, a market leader like VMware gets more attention than the other players and probably gets too much credit – and also too much grief – with the ups and downs of the market, he said.