VMWare, Inc. (NYSE:VMW) beat earnings expectations. Now, the virtualization company faces a conundrum as the completion of its takeover by Dell Inc looms. A merger creates uncertainty for VMWare stock, which has nearly tripled in the last two years. How VMW will integrate into the privately held Dell after a merger remains unclear. Given merger uncertainty, investors should look to how VMWare combines with Dell before taking a position in the stock.
Despite merger concerns, the company reported great news on the earnings front. Q4 EPS came in at $1.68-per-share, beating earnings expectations by 6-cents-per-share. This compares to the $1.43-per-share reported in Q4 2016. However, this figure excludes a one-time, non-cash tax charge of $970 million due to the Tax Cuts and Jobs Act. Including the tax charge, earnings came in at a $1.04-per-share loss.
Revenues of $2.31 billion beat estimates by $50 million; revenues also rose 13.8% on a year-over-year basis. License revenue claimed $1.07 billion of revenues and increased 20% from year-ago levels. Full-year revenues came in at $7.92 billion, of which $3.19 billion came from licenses. Non-GAAP annual income was $5.19-per-share, which is up from $4.39-per-share in 2016 and higher than the expected $5.14-per-share.
The company also raised guidance as it expects fiscal 2019 to bring $6.02-per-share on revenue of $8.73 billion. Analysts had predicted $5.59-per-share with revenues of $8.64 billion.
Dell Merger Looms Too Heavily Over VMWare Stock
The California-based company provides cloud computing and platform visualization software and associated services. Dell (which should not be confused with the VMWare-tracking stock Dell Technologies, Inc. (NYSE:DVMT)) owns an 80% stake in VMWare.
Dell is focused on a “reverse merger.” In this deal, Dell would buy the remaining 20% of VMWare and take the combined company public. Still, DVMT stock rose on the news as a merger would mean a buyout of the tracking stock. Report of this merger took VMW stock down. Many investors fear a takeover by Dell due to a high level of indebtedness.
VMWare specializes in software virtualization. This allows one PC or server to perform the work of multiple machines by mimicking their behavior. Like with its peer Microsoft Corporation (NASDAQ:MSFT), licensing this software has been particularly lucrative as licensing revenue growth has exceeded overall revenue growth for VMWare.
This popular software has served as a boon to VMWare stock. The equity, which traded below $44-per-share two years ago, now trades well over $122-per-share. This is even after a somewhat negative reaction to the earnings report.
I love their product, and I think VMWare has a bright future with or without a Dell merger. However, with the stock price increases over the last two years, it trades at a fair valuation. And with the now-private Dell combining with the company, the financials of the full company remain unknown. Moreover, with its 6% drop right before the company announced earnings, and its falling even further after the next day’s trading, investors have not taken the merger news well. Hence, staying away from VMWare stock might stand as a prudent move for now.
The Bottom Line on VMWare Stock
VMW stock has shown impressive growth. However, with the uncertainty coming from a Dell merger, investors should move to the sidelines.
VMW beat both quarterly and annual earnings estimates as its virtualization success and increased licensing revenue have impressed investors. But news of a complete takeover by Dell sent the stock reeling in trading the next day. Dell carries a heavy debt load. Moreover, since the company remains private, details of its financial situation remain beyond the view of outside investors. With this level of uncertainty, it’s time to move to the sidelines on VMWare stock.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks.