- EMC's board is reportedly exploring a buyout by subsidiary VMware.
- The deal would involve VMware issuing a huge amount of new shares which would result in considerable share dilution.
- But VMware would reap huge dividends as a result, including getting cheap sales and owning EMC's wildly growing All-Flash Arrays business.
There are widespread speculations that king of server virtualization, VMware (NYSE:VMW) might end up buying parent company EMC (NYSE:EMC) in a downstream merger. Famous activist investor Elliot Management has been piling pressure on EMC to divest its majority 80.6% stake in VMware, a move the EMC CEO Joe Tucci has adamantly been opposing. Mr Tucci has been in favor of a spin-in where EMC would buy the remaining stake in VMware that is does not already own.
But with a standstill agreement between EMC and Elliot due to expire on Sept. 1, EMC is now exploring new options, including being bought out by its subsidiary. If EMC’s board approves a merger with VMware, VMware would issue new shares worth about $50 billion-$55 billion, of which shares worth about $30 billion would be used to cancel EMC’s stake in the company. The remaining shares would be issued to EMC shareholders, who would also get some cash after VMware issues new debt worth about $10 billion. Elliott Management is reportedly open to a downstream merger between the two companies.
The proposed deal seems reasonable enough for EMC shareholders. But what’s in it for VMware shareholders?
Cheap sales, huge cost savings
One of the biggest benefits VMware would derive from an EMC buyout is getting substantial revenue on the cheap. EMC finished fiscal 2014 with $24.4 billion in sales, about four times VMware’s sales. And those are very cheap sales--EMC shares currently trade at about 12 times expected 2016 earnings compared with more than 20 times forward earnings for VMware. EMC shares are of course that cheap because the company’s top line growth of 5% is less than a third of VMware’s growth reading of 16%. EMC’s core data storage business grew just 2% last year as the segment continues to face mounting pressure from newer storage technologies such as flash arrays.
The merged company would also be able to realize huge cost savings, which would of course trickle to the bottom line. RBC Capital Market estimates that the resulting cost synergies that would emerge from a merger would help the company save as much as $946 million in 2016 alone.
All-Flash Arrays business
Despite EMC’s faltering storage business, it still owns a real gem that could easily become one of VMware’s greatest growth drivers in a few years’ time--all flash arrays business. EMC is the world’s largest manufacturer of all flash arrays, the fastest growing storage business.
EMC saw its all-flash sales more than double in 2014, and expects sales to double again in the current year to exceed $1 billion. This will become the company’s fastest product to hit the $1 billion mark. EMC has its 2012 Extreme IO acquisition to thank for its strong position in the flash arrays business.
IDC pegged the all-flash business at $1.3 billion by the end of 2014, and the hybrid flash arrays at $10.0 billion. The rapid decline in the prices of SSDs has been encouraging more companies to explore all-flash arrays rather than hybrid arrays as has been the case in the past. This trend is expected to continue over the coming years, thus giving all-flash manufacturers strong growth runways. One big advantage a company like VMware would have over all-flash rivals such as Pure Storage lies in the fact that it’s already solidly profitable, and could even afford to undercut its competitors in pricing to further increase its market share. Pure Storage has seen its losses grow even faster than its sales, which places the company in a perilous position if pricing wars start escalating.
Chance to eliminate competing EMC products
VMware and EMC have lately been increasingly competing directly as the two companies launch similar product lines. VMware started selling vSAN, the company’s software-defined storage product, in 2014. vSAN works very similar to EMC’s ViPR, and the two products compete directly. VMware could chose to integrate competing EMC products directly with its own products or even kill them off.
Downstream mergers are quite rare, and VMware’s acquisition of EMC is far from being a sure thing. 5 out of 9 VMware board members sit on EMC’s board as well. EMC has more than 97% voting control over VMware stock, meaning that it’s EMC rather than VMware that will determine whether or not a merger takes place at the end of the day. But if it does, it appears that VMware will reap big dividends from the deal.