- A look into the federal structure of EMC
- Growth of cloud computing and how EMC can pursue an aggressive policy in this fast growing market.
- Advantages of selling the stake in VMware
In the past few months a lot of ink has been used up in analyzing the workings and future direction of EMC Corporation (NYSE:EMC). EMC offers virtualization, data storage and cloud computing services which helps businesses to store, protect and analyze the data generated during business operations. It was in talks with HP for a possible merger, however the talks ended without reaching a successful conclusion. There are also increasing noises that it is in talks with other firms who might like to merge with the company or buy it outright.
EMC is currently valued at $60 billion with a P/E of 23.63. It has a unique corporate structure where it is holding majority stake in its subsidiary VMware (NYSE:VMW) and Pivotal. VMware provides virtualization and cloud services whereas Pivotal combines the offerings of EMC and VMware to deliver PAAS services. EMC has 80% stake in VMware which is valued at $37.2 Billion and P/E of over 41. The company functions in a federal structure where the CEO of VMware and Pivotal report to Joseph Tucci, the Chairman and CEO of EMC. This kind of ownership structure has created additional issues because many of the products made by VMware and EMC are cannibalizing each other.
Over the past few years there has been a seismic shift in the technological sphere. The vintage products have been overtaken by new offerings. This has also led to changes in the working of tech organizations. One of the major talking point in the past few years has been cloud computing and Big Data. Cloud computing brings centralized data storage and the ability to have online access to different computer services. With the growth of smartphones, tablets and other devices there has been a deluge of data collected and transferred from these devices. Apple’s iPhone and iPad devices were responsible for over 50% of data usage whereas Samsung devices came second at 24% in 2013.
With the gargantuan amount of data created comes the requirement of storing them responsibly and analyzing them. This field is contested by several companies including EMC, HP (NYSE:HPQ), NetApp (NASDAQ:NTAP) and IBM (NYSE:IBM). Through a possible HP-EMC merger, the two companies were looking for consolidating their offerings and creating a better collective cloud offering to their customers. However given the overall workings of the two firms it seems a wise decision that the merger talks were left in cold storage. Any merger between these two firms would have led to increased confusion over the products offered, the workings of various subsidiaries and also would have reduced the agility of the merged entity to work in the ever changing technological sphere.
Many firms have been investing heavily in their R&D efforts to bring better products. NetApp, which is considered as one of the main competitor of EMC has been spending heavily on its R&D efforts.
Figure 1: Trailing twelve months of R&D expense to revenue for EMC (Blue) and NetApp (Orange)
EMC has been aggressively pursuing share buybacks for the past few quarters. It can curtail this exercise and put the cash into R&D or acquiring startups which can give a better pipeline of future products. The firm has spent over $9.6 billion in the past 4 years for share repurchases. Although EMC has an increasing cash flow it would be better if the firm makes investments in consolidating its product offerings and increasing its R&D.
Finally EMC has been in the news for the increasing pressure it is facing from its investors to split from VMware. EMC acquired VMware in 2004 for $635 million. It provides virtualization and cloud services and VMware was listed on August 14, 2007, and EMC still controls over 80% of this company. The problem is that VMware is still growing and has a lot of potential whereas EMC is a much more mature company in an overall crowded sector. VMware has been giving better returns than EMC for the past 5 years.
Figure 2: Comparison of total returns by VMware and EMC
By keeping the two companies together in a federal structure the overall potential of the faster growing VMware is reduced and it also hinders any consolidation effort of the parent EMC. By selling the entire stake of 80% EMC can gain cash infusion of $30 billion which can be used for consolidating its place in the storage market and also help in gaining newer technologies through acquisitions.
The highly competitive cloud computing space will eventually bring around consolidation. Few firms will come out unscathed from the current price cuts in the cloud prices. Microsoft (NASDAQ:MSFT) which has been trying its best to get a foothold in this turf has been able to garner a growth of over 164% whereas IBM grew by 86% in comparison to the market leader Amazon (NASDAQ:AMZN) which had a growth of 49%. This points to changing developments in the cloud arena and if any firm wants to remain relevant it would need to have huge cash. Within the cloud space any investment has to be quite huge to build the requisite capacities. A billion dollar investment in a quarter is just an ante in this game. Players like Google (NASDAQ:GOOGL) can invest a lot in building their cloud capacity. EMC can use the cash from the sale of VMware to get a stronger foothold in this market.
Although Amazon is at the head of the pack, the situation can change very fast. According to Forrester Research the cloud space is at a “hypergrowth” stage. This is a point where old market leaders in cloud may get dethroned by new challengers. An ideal example is Blackberry which saw a total erosion of its market by Apple’s iPhone even though it was the first entrant. This is the ideal time to look for growth drivers within the cloud space and build a wide moat around them in order to have a long and sustainable growth.
EMC has been quite active in the acquisition front. Some of its acquisitions have paid huge dividends like VMware and RSA Security. However there are other acquisitions which might hinder the growth of some of the current products and services of EMC. One of them is ScaleIO which was acquired in 2013 to strengthen the flash portfolio of the company. VMware on the other hand launched vSAN which also provides software defined storage similar to ScaleIO. Both of them have similar architectural models and are block-based software stacks. EMC claims that ScaleIO is able to support a wider variety of servers and is able to scale better than vSAN. Still the jury is out on how much this product will help in providing additional capability to EMC.
Going forward EMC will need to divest its stake completely or partially in VMware to concentrate on its core products. This additional cash can be used to increase its current offerings and also help in strengthening its position in the market.