Zacks Small Cap Institutional Research



|VMware, Inc. |(VMW - NYSE) |$135.02 |

Note: This report contains substantially new material. Subsequent reports will have changes highlighted.

Reason for Report: 4Q18 Earnings Update

Prev. Ed. Prev. Ed.: Dec 18, 2017: 3Q18 Earnings Update

Firms’ Recommendations: Positive: 53.9% (14 firms); Neutral: 42.3% (11); Negative: 3.8% (1) Prev. Ed: 17; 9; 0

Firms’ Target Price: $138.62 (↑$7.67 from last edition; 21 firms) Firms’ Avg. Expected Return: 2.7%

Note: A flash update was done on Mar 2, 2018 (4Q18 Earnings Update)

*Note: Although dated Apr 23, 2018, the data in the tables below are as of Mar 7, 2018

Note: The tables below (Revenues, Margins and Earnings per Share) contain material from fewer brokers than in the Valuation table. The extra figures in the Valuation table are taken from reports that did not have accompanying spreadsheet model.

Note: We do not have access to firm reports presenting negative rating on VMW

Portfolio Manager Executive Summary

VMware Inc. (VMW) is a leading provider of virtualization solutions. Its product portfolio addresses the needs of a vast consumer base that includes personal desktop to enterprise data center, including virtualization platforms, virtual infrastructure automation and virtual infrastructure management. Enterprises rely on VMware to reduce capital and operating expenses, ensure business continuity and strengthen security.

Key factors for evaluating an investment strategy for VMware are as follows:

• VMware is broadening its product portfolio to cater to the expanding requirements of its customers and assures recurring revenue streams

• The company is one of the dominant players in the server virtualization market

• Citrix and Microsoft are the primary competitors of VMware.

Of the 26 firms covering the stock in the Zacks Digest Group, 14 provided a positive rating, 11 provided a neutral rating and one provided a negative rating on the stock. Target prices range from $90.00 to $175.00, with the average price being $138.62. The average expected return over the current price is 2.7%.

Notably, VMware revised its fiscal calendar effective Jan 1, 2017. The company’s first fiscal year under its revised calendar began on Feb 4, 2017 and will end on Feb 2, 2018. Hence, its fourth-quarter fiscal 2018 began on Nov 4 and ended on Feb 2, 2018.

Bullish Stance (Buy or equivalent) – 14 firms or 53.9% –The bullish firms believe that VMware’s improved positioning in the public cloud, resilience of its core vSphere business and growing traction of its new products—NSX, vSAN/VxRail, EUC Airwatch, vCloud Air Network—can be major growth drivers. The firms are positive about the increasing renewals for vSphere and rising adoption of VMware Cloud (VMC) on AWS. Also, the new Cross Cloud Strategy is expected to boost the top line, going ahead. These firms expect VMware to pursue acquisitions that will broaden its portfolio. These will expand the company’s ability to help customers transition to hybrid cloud. Further, after Dell’s acquisition of the company’s parent, VMware is witnessing some benefits from the relationship, which is another positive. New virtualization opportunities are also a tailwind for the company. The firms also believe that VMWare will benefit from the growing opportunities in networking and storage. Moreover, demand for its solution from the public sector, which includes the federal contracts, is also expected to be accretive to growth.

Cautious Stance (Neutral or equivalent) – 11 firms or 42.3% – The firms with a neutral outlook prefer to wait for better visibility in desktop virtualization in the emerging markets and recovery in IT spending. These firms choose to remain on the sidelines over the long term as server virtualization is likely to mature, thereby limiting the scope for growth. Further, the firms believe that several of the growth engines that the company is relying on could take longer to yield results. They are also concerned about the sudden lack of growth for hybrid cloud and software defined data center. Moreover, increasing competition from Microsoft, Citrix, OpenStack and even some start-ups can pose a threat going forward. The firms are also apprehensive regarding the outcome of Dell’s evaluation of “potential business opportunities”, which include Dell’s purchase of outstanding shares in the company or selling itself in a reverse merger. Rising competition from Red Hat is also an overhang.

Bearish Stance (Sell or equivalent ratings) – 1 firm or 3.8% –

Apr 23, 2018

Overview

VMware, Inc. was founded in 1998 and is headquartered in Palo Alto, CA. The company develops and markets its product and service offerings within three main product groups. These are SDDC or software-defined data center, End-User Computing and Hybrid Cloud Computing.

The firms have identified the following key factors for evaluating the investment merits of VMware:

|Key Positive Arguments |Key Negative Arguments |

|The company is one of the leading players in the virtualization software |Given VMware’s substantial operating expenses to maintain its leading |

|market |position in the industry, its operating margin could suffer a decline |

| | |

|VMware offers high return on investments to its customers as it dominates |VMware faces significant competition from Citrix Systems and Microsoft |

|the virtualization market with its x86 servers | |

| |Sluggish macroeconomic environment and weaker-than-expected IT spending are|

|The company has a multi-tiered distribution strategy, which makes it unique|headwinds for the company |

|in the industry | |

VMware and its subsidiaries provide virtualization solutions that separate the operating system and application software from the underlying hardware to improve efficiency, availability, flexibility and manageability. The company's solutions enable organizations to aggregate multiple servers, storage infrastructure and networks together into shared pools of capacity that can be allocated to applications as needed. The company's virtualization platforms include a hypervisor for system partitioning that provides the capability to run multiple operating systems simultaneously on the same physical machine. VMware defines hypervisor as a layer of software that resides between the operating system and system hardware to enable virtualization. The company's virtual infrastructure automation products utilize its virtualization platforms to automate system infrastructure services, such as resource management, availability, mobility and security. These products improve runtime, availability and reliability of the virtual machines. VMware's suite of virtualization solutions address a range of complex IT problems, including infrastructure optimization, business continuity, software lifecycle management and desktop management.

The first quarterly result after VMware’s parent-company EMC Corporation was acquired by Dell Inc. for $67 billion in September was for 3Q16.

VMware declared that it will be undergoing a transition between Jan 1 and Feb 3, 2017. This apart, from Feb 4 onward its calendar will be aligned with Dell fiscal 2018 calendar wherein its first quarter will be from Feb 4 to May 5, 2017. The company will report the results of the transition period in the first 10Q of fiscal 2018.

The new company called Dell Technologies holds approximately 80% of VMware shares, which were earlier held by its parent EMC. The remaining 20% of the shares are held by shareholders and continue to trade. Dell created a tracking stock from 53% of the value of total VMware shares. Following the acquisition, Michael S. Dell took over the role of Chairman of VMware’s board of directors, replacing Joseph M. Tucci.

Additionally, VMware announced the formation of a new Products and Cloud Services organization that spans compute, storage, networking, management, and business mobility. Raghu Raghuram and Rajiv Ramaswami will co-lead this new organization and will serve as co-chief operating officers for Products and Cloud Services.

For further information on the company, please visit .

Apr 23, 2018

Long-Term Growth

The firms believe that despite the completion of the EMC-Dell merger, its long-term growth prospects largely remain unchanged. Even under the new management, Dell and VMware remain an open eco-system, which will allow the latter to maintain its earlier partnerships. The long-term earnings growth rate of the company is projected to be 12.3%.

However, as a result of the acquisition, the number of VMware shares in the market has increased. This is because Dell created a VMware tracking stock linked to EMC’s economic interest in the company, which was around 53% of the total VMware ownership. Of the rest, 28% of the stock is now owned by Dell and 19% is traded in the open market.

Dell now holds maximum voting rights in VMware. Dell projects synergies of approximately $1 billion in revenues apart from significant expansion in VMware’s businesses including software defined data center, end-user computing and hybrid cloud services.

The firms believe that VMware is successfully extending its virtualization software capabilities beyond servers and into other areas such as networking and storage. The company’s growth is likely to be driven by two key strategies - diversification of the product portfolio to most of the IT infrastructure and a novel product strategy based on “one cloud, any application, any device” framework.

VMware has been strengthening its offerings with updated Cloud Management Platform, vRealize Automation 7.0 and vRealize Business. In addition, the company is offering vCloud Air services, which include vCloud Air Object Storage, vCloud Air SQL and a couple of new technology previews namely, VMware vSphere Integrated Containers and VMware Photon Platform.

In the past, the company launched its products in domains like software-defined data center (vSphere, vSAN, NSX), hybrid cloud (vCloud Air, vCloud Air Network) and end-user computing (AirWatch, Horizon). On the other hand, its product strategy is aimed at enhancing SDDC (making it mainstream), vCloud Air (establishing it as an important hybrid cloud platform), getting an edge to win customers in network architecture (especially in NSX and vSAN) and solidifying its position in the business mobility market.

The future of server virtualization will most likely be centered on functionality beyond base virtualization provided by the hypervisor. Over the last few years, the company has successfully dominated the hypervisor market. However, as enterprises begin to use functionalities beyond the hypervisor, the company is expected to face significant competition for market share.

VMware believes that ELAs have the potential to grow significantly within the next 1-2 years. The company believes that it must continue to dedicate a significant amount of resources to research and development efforts to maintain its competitive position in the long run. However, it may not receive significant revenues from these investments for several years, if any at all. In that case, this heavy spending on R&D may weigh heavily on its margins in the near future unless offset by a rise in revenues.

VMWare also believes that it is well positioned to benefit from the robust spending levels in software defined data center, hybrid cloud and end user computing over the long term. The company’s collaboration with Pivotal Software Inc and Google Cloud to unveil Pivotal Container Services (PKS) reflects its growing commitment to create a hybrid cloud market.

The firms also believe that the company is likely to benefit from its ongoing efforts in developing product portfolio for IT infrastructure domain including software-defined datacenter, hybrid clouds and end user computing (EUC).

The firms expect VMware to face increased competition from the likes of Microsoft, going forward. The company will likely experience longer sales cycles, leading to a reduction in revenues and possibly profit margins. Apart from Microsoft, the company also faces competition from other software vendors, such as Citrix. The firms also expect increased competition from open source companies like Red Hat.

However, with innovative virtualization products and cloud suit solutions, VMware continues to witness robust growth in the virtualization market, which has grown in double digits. This will help VMware increase its addressable market and installed base, as well as strengthen its competitive position.

The firms believe that VMware’s dominance in core x86 server virtualization software provides a powerful foundation for addressable market expansion. This in turn may lead to workload migration to the public cloud, which could be a major obstacle for the base business, and several of the growth engines the company is relying on could take longer than expected to materialize.

Moreover, the firms believe that over the long run, emerging container technologies could pose a fundamental threat to stand-alone hypervisor vendors such as VMware and Citrix that do not own their own operating systems.

Apr 23, 2018

Target Price/Valuation

Provided below is a summary of valuations and ratings as compiled by Zacks Research Digest:

|Rating Distribution |

|Positive |53.9%↓ |

|Neutral |42.3%↑ |

|Negative |3.8%↑ |

|Digest High |$175.00↑ |

|Digest Low |$90.00 |

|Avg. Target Price |$138.62↑ |

|Firms with Target Price/Total |21/26 |

Risks to the target price include – competition from Microsoft, Citrix and the open-source community, challenges associated with any new technology, lack of traction in ancillary markets and increasing pricing pressure as other companies improve their virtualization solutions.

Recent Events

On Apr 17, 2018, VMware announced the launch of VMware vSphere 6.7 and VMware vSAN 6.7 to help in enhancing user experience, security, application support and hybrid cloud management features.

On Apr 4, 2018, VMware appointed Jenni Flinders as vice president, Worldwide Channels.

On Mar 29, 2018, VMware announced an update to its vRealize cloud management platform that will enable easier implementation, usage and management of hybrid cloud environments.

On Mar 21, 2018, VMware announced an update to its Workspace ONE platform, making it the industry’s first intelligence-driven digital workspace to empower user experience and boost predictive security.

On Mar 7, 2018, VMware announced the availability of Amazon Web Services (AWS) in Europe as well as new capabilities to accelerate cloud migration and simplify hybrid cloud deployments.

On Mar 1, 2018, VMware reported 4Q18 results. Highlights are as follows:

• Non-GAAP EPS was $1.68, up 17.5% y/y

• Revenues increased 13.6% y/y to $2.31 billion

Revenue

Per the 4Q18 press release, revenues of $2.31 billion increased 13.6% y/y, primarily driven by robust performance from NSX and vSAN product line.

Provided below is a summary of revenue as compiled by Zacks Digest:

|Revenues ($ in millions) |4Q16A |

|Copy Editor | |

|Content Ed. | |

|QCA |Aniruddha Ganguly |

|Lead Analyst | |

|Reason for Update |4Q18 Earnings |

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April 23, 2018

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