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VMWare Is a Bit Pricey, but the Best Cloud Stock Out There

What is the future for “cloud” and VMware (NASDAQ:VMW)? Is VMW a possible subject for a buyout? — Terry

Ah, cloud computing. The hot phrase in tech for the last few years continues to be one of the biggest areas of interest (and confusion) for investors.

For starters, I’ll answer your question in short form: The cloud is here to stay, and businesses continue to use companies like VMWare to “virtualize” operations and cut costs. For that reason, I like this stock, even if it is a bit pricey.

But as for a buyout? Not likely. Without a penny of premium baked in, the market cap of this stock is $38 billion. Deals that size have been made, of course, but for an acquirer to find the money and then digest a company on this scale is no easy feat, even in rosy economic times.

So, if you want to buy, buy for the big growth potential cloud computing provides.

Now let’s back up a bit for those of you who may not understand the cloud computing craze. Consider that Amazon (NASDAQ:AMZN) allows you to buy books and movies and store them on its servers and access them anywhere from any wired device. That’s storage “on the cloud.” Same for Apple (NASDAQ:AAPL) and its iTunes — excuse me, iCloud — for your music library. Same for Google (NASDAQ:GOOG) and its Google Drive for documents and photos.

The cloud doesn’t have to just offer storage of files, however. Many companies are providing software and applications on the cloud. Microsoft (NASDAQ:MSFT) has put its landmark Office software up there. And (NASDAQ:CRM) provides customer relationship management software (hence the ticker) that’s accessible from anywhere via the cloud.

I could go on, but the bottom line is that the general idea of “cloud computing” is thriving across almost every business.

This leads us back to VMWare. It’s one of the few pure plays on the growth in cloud computing, because it styles itself as “a leading provider of virtualization and virtualization-based cloud infrastructure solutions.” In short, any company that wants to use cloud computing to build its business needs VMWare’s help to do so.

It’s no surprise then that VMW stock has soared as this kind of technology has come into favor. It’s up 300% since January 2009, about six times the broader stock market! A look at its earnings and revenue also show impressive growth, with 12 straight quarters of year-over-year revenue increases and fiscal 2012 earnings set to more than triple 2010 numbers.

But VMWare has underperformed in the last 12 months or so. That’s partly because it outran its growth — even after strong earnings, it has a rich forward P/E of almost 29 at current valuations.

It doesn’t help that VMWare’s business is cyclical and the economy has lost momentum, too. After all, businesses need cash to spend on these virtualization plans, and customers to buy the products and services they put up there when the cloud infrastructure is completed.

Last but not least, competition from other virtualization stocks like Citrix (NASDAQ:CTXS) and Red Hat (NYSE:RHT) is making things tougher. VMW is bigger than these two players combined, but it’s a tough market out there for those macro reasons.

Those are the risks, plain and simple. But I like this company — especially if the stock continues to pull back. There’s obviously a lot of opportunity here as companies continue to cut costs, provide better services and connect with new customers through virtualization. The services that VMWare provides are not going away.

And as InvestorPlace writer Tom Taulli pointed out just a few months ago, the ecosystem of partners VMW has is a huge barrier to entry. Tom writes: “Over the years, VMware has assembled more than 2,100 technology partners, including Cisco (NASDAQ:CSCO), Dell (NASDAQ:DELL), Fujitsu, Hewlett-Packard (NYSE:HPQ) and IBM (NYSE:IBM). These arrangements have helped to improve VMware’s technology as well as boost the market penetration and brand.”

There’s obviously opportunity here because just about every tech company is using the cloud. And VMW is a great way to do that. Just be wary of the risks, and the chance that you may be chasing a pretty high P/E at current levels. The stock pulled back to $80 in July, it’s lowest level since January, and there’s a chance it may retest those lows before year’s end.

Final note: Don’t buy into the cloud hype of some stocks like Salesforce. The bottom line is that Salesforce provides business services the same way Paychex (NASDAQ:PAYX) does. Salesforce just happens to do it virtually. In my opinion, you should no sooner be consider this a “cloud computing stock” any more than you would consider General Motors (NYSE:GM) or Whirlpool (NYSE:WHR) “metal stocks.” AMZN uses the cloud, but it’s an online retail stock at its core.

In the 2000s we fell into the trap of calling companies “Internet stocks.” But nowadays we know Amazon is a retailer, Priceline (NASDAQ:PCLN) is a travel site and Yahoo (NASDAQ:YHOO) is a media stock.

Don’t make the same mistake of using “cloud computing” as a catch-all.

Jeff Reeves is the editor of and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

Article printed from InvestorPlace Media,

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