EMC is scheduled to announce its Q2 earnings on July 23. The company posted mixed results in the first quarter, with net revenues growing by less than 2% year-on-year to $5.48 billion. EMC’s information infrastructure product sales, which include storage products, RSA security and content management software, declined by almost 7% year-over-year to $2.4 billion. The company witnessed significant top line growth from VMware (+16%) and Pivotal (+40%).
EMC’s market share in external storage systems declined from 30.2% in Q1 2013 to 29.1% in the first quarter of 2014, according to a recent report by IDC. This was the first quarter since 2008 in which EMC’s market share declined year-over-year. Weakness in the core business has led to market speculation about EMC spinning off VMware and Pivotal. The Wall Street Journal reported that external pressure from EMC’s large institutional investors could lead the company to spin off some of the fastest-growing businesses within the company such as VMware and Pivotal.
We have a $30 price estimate for EMC, which is roughly in line with the current market price.
Speculation Over VMware And Pivotal Spin-off
According to the aforementioned WSJ report, Elliott Management has taken a stake of over $1 billion in EMC, making it one of the top five institutional investors. Elliott Management has previously held shares in Juniper Networks, Riverbed Technology and Brocade Communications Systems, and has subsequently pushed management for changes to aid shareholders.
In the last twelve months, EMC’s stock price has increased by 11% while VMware’s stock has risen by 31%. The hedge fund could point out to EMC that its present operational structure is impeding growth. On the other hand, EMC’s management has stuck to its “federation” business model wherein some of the acquired companies operate as separate entities, while they still collaborate on products for large clients. In the current setup, it’s a win-win for both EMC (since it can offer better products and services to big customers) as well as VMware and Pivotal, as they are able to strike deals with EMC’s larger client base. The company is likely to provide more color regarding these possible developments in its earnings call. According to a Bloomberg report, if the company does go through with the spin-offs, there is a possibility that EMC (minus VMware and Pivotal) gets acquired by a tech giant such as HP, IBM, Cisco or Oracle.
Key Areas Of Growth: Emerging Storage, VMware, RSA Security And Pivotal
EMC’s Emerging Storage products such as XtremIO, Isilon, Atmos and VPLEX were largely responsible for the growth in hardware sales during the past few quarters. Revenues generated by the emerging storage sub-segment constituted only about 10% of the EMC’s Information Storage revenues in 2013. The Emerging Storage sub segment grew by 81% year-over-year (y-o-y) in Q1 2014, which the company attributed to a strong customer response for these products. However, the company did not provide exact figures for emerging storage revenues in Q1.
RSA Security, EMC’s information security division, grew by over 11% to almost $1 billion in 2013. The growth continued in Q1 2014, but the rate of growth was lower than 2013 at less than 5% y-o-y. The information security industry is growing, with customers allocating more of their security budgets to intelligence-driven analytics, where RSA Information Security excels, rather than static prevention.
Pivotal is among the fastest growing divisions within the company, with 40% y-o-y growth in the first quarter. Pivotal’s platform consists of new generation data fabrics, application fabrics and a cloud-independent Platform-as-a-Service to support cloud computing and Big Data applications, which have started gaining traction among customers. Management mentioned that some of Pivotal’s growth may not be immediately realized in the numbers since Pivotal is building out a subscription-based revenue stream, which is likely to be beneficial in the long run.
VMware has given revenue guidance of about $1.45 billion for the quarter, which is more than a 15% increase over the prior year quarter. The company expects to generate close to $6 billion in revenues for the full year. With a healthy customer response to VMware’s new product offerings and the growing services department, we expect the company to meet its guidance. According to our estimates, all these divisions are likely to grow at a rate higher than that of core storage products. But since information security and pivotal combined constitute only about 5% to the company’s value, EMC’s emerging storage division and VMware’s performance are more likely to drive its overall earnings.