Information technology powerhouse EMC (EMC) is at a crossroads now: Longtime CEO Joe Tucci plans to retire soon, potential merger partners are circling and activist investors are looking toward boosting the value of EMC stock by breaking up the $60 billion giant.
These are obviously challenging times for the enterprise storage hardware vendor, even though EMC has an abundance of riches in its executive ranks and spinoffs like majority-owned virtualization unit VMware (VMW) and Pivotal Software — which are focused on two high-growth IT sectors: virtualization/cloud services and Big Data analytics.
Rumors continue to swirl that EMC could be a merger target — the company reportedly had been in merger talks with rival Hewlett-Packard (HPQ) for about a year, although the negotiations recently broke down. PC World reported that EMC also has held talks with Dell (DELL).
Why the sudden interest in getting EMC hitched now? At least part of the urgency stems from the recent wave of equity activism sweeping through the tech sector.
Paul Singer’s hedge fund Elliott Management, whose 2% stake in EMC amounts to about a $1 billion investment, has been turning up the heat on EMC to sell off parts of its business in recent weeks. The biggest jewel: EMC’s 80% stake in VMware — one of the best plays on server virtualization and cloud infrastructure.
Elliott’s 33-year-old wunderkind Jesse Cohn is turning up the pressure on EMC to break up its business units to maximize shareholder value — reducing EMC’s 80% stake in VMW is a key target. Cohn is at the top of his game, a fierce dealmaker who recently concluded the deal for Compuware.
However, a breakup may not be the best move to boost the value of EMC stock . That’s because EMC’s “Federation Strategy,” announced by Tucci earlier this year, could make EMC far more valuable than the sum of its parts. While the “Federation” might sound like a Star Trek buzzword, it is a redefined — and almost vendor-agnostic — strategy to build new software defined server, networking and storage solutions for customers.
The Federation strategically aligns all three of EMC’s businesses EMC Information Infrastructure, VMW and Pivotal. At EMC World in May, VMW CEO Pat Gelsinger described the Federation strategy as “tightly aligned, loosely coupled.” That means each of the businesses can coordinate on customer solutions across trends like cloud, Big Data, mobile and social networking, but customers will still be able to select products from other IT vendors, integrating them to deliver best-of-breed solutions.
As Tucci prepares to ride off into the sunset, EMC has four potential successors:
- Gelsinger, the former head of EMC’s infrastructure product unit, was named CEO of VMware in September 2012.
- Paul Maritz, former VMware CEO, is CEO of Pivotal — a spinoff of EMC and VMW focused on custom, cloud-based applications for big data analytics.
- Former CFO David Goulden, who was promoted to CEO of EMC’s Information Infrastructure business in January
- Howard Elias, president and chief operating officer of EMC’s Global Enterprise Services.
Barring a sale of VMW, I think Gelsinger is the odds-on favorite to succeed Tucci.
EMC has been resilient this year — EMC stock is up 18% year-to-date. Of course, it also trades at a price-to-earnings ratio near 14, and more importantly, a price/earnings-to-growth ratio of nearly 15, indicating some froth in shares. Meanwhile, EMC’s dividend yield of 1.6% isn’t going to bring income investors into the fold.
And like all IT giants, EMC faces significant challenges as legacy — and lucrative — hardware products have been displaced by cloud infrastructure and a move to software-defined networks (SDN).
However, while merging with HP Q– or another IT giant like Dell (which is battling similar trends) might look good on paper, it could limit EMC’s ability to build profitable, customized and vendor-agnostic solutions.
On its own, EMC doesn’t look all that bad bad — profit margins and revenue are growing, cash flow remains strong and the company has a deep bench of talented executives to keep EMC focused and moving forward after Tucci retires.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.