VMWare, Cisco Expand Strategic Partnership to Deliver Next Cloud Infrastructures

Edited by Juna Yanoyan

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VMWare Inc. (NYSE:VMW) provides virtualization and virtualization-based cloud infrastructure solutions that support a wide range of operating systems, application environments and networking and storage infrastructures. The three main product groups of company are: cloud infrastructure and management, cloud application platform and end-user computing. The company is getting almost half of its revenues from USA and the other half from the rest of the world.

INVESTMENT TRIGGERS

VMWare Inc. sales and net income have grown at CAGR of 30% and 35% respectively since 2007. The company has a strong balance sheet with cash and short-term investments of $4.51 billion and no debt. The company is focusing on development of products for growth markets like Platform as a service (PasS) and Software as a service (SaaS) and making technology acquisitions in order to expand its product line.

For example, acquisition of Wanova Inc. in May 2012 will strengthen its position in virtual desktop market which is projected to increase from $500 million in 2009 to $5 billion in 2016. Asia Pacific and Japan region witnessed 81% growth in revenue in Q2 2012 and further growth is expected from demand of government agencies and defense departments in this region. Focus of the economic plan of China on cloud computing for IT industry also provides growth opportunities for the company.

VALUATION

Our DCF valuation model values each share of the company at $100.71. At WACC of 6.8%, the equity of the company is valued at $42.952 million which consists of DCF stream of $14.377 million plus terminal value of $28.671 million less financial assets and net debt. WACC assumes Beta of 1.23, risk-free rate of 1.72% being yield on US treasury and market premium of 4.1%.

INVESTMENT RISKS

The competitive pressure from other companies like Microsoft (NASDAQ:MSFT), Citrix Systems (NASDAQ: CTXS), and Linux may affect pricing. Any slowdown in the world economy or Eurozone crisis resulting into a decrease in global IT spending and federal spending may affect growth of the company. The company has limited number of distributors, and three of each distributor contributes more than 10% of the revenue. Further, 47% of total accounts receivable are from only three distributors. It also has weak operating cash flow.

INVESTMENT STRENGTHS

VMW has solid revenue growth, reasonable debt levels, expanding profit margins, notable return on equity and increase in stock price during the past year. The revenue growth came in higher than the industry average of 8.2%. Revenues rose by 21.9% compared to the same quarter last year. It has a very low debt to equity ratio at 0.08 which reflects good debt management. The current ratio is a strong 2.45.

NEWS AND CALENDAR

30-Aug-12 Longbow Initiated  Buy $110

21-Aug-12 Mizuho Reiterated  Buy from $105 to $115

24-Jul-12 Needham Reiterated Buy from $127 to $112

24-Jul-12 Mizuho Reiterated Buy from $105 to $107

09-Jul-12 Wunderlich Reiterated from Buy $120 to $100

RECOMMENDATION

We recommend a BUY for VMW. The company expects to generate substantial profits and revenues are expected to grow from its latest IT strategies. It is trading at a discount now with huge potential for expansion through its healthy balance sheet.