VMware (NYSE:VMW) has become International Business Machines’ (NYSE:IBM) worst nightmare.
Long the leader in virtualization, VMware has made a turn toward the market IBM is now targeting. VMware looks likely to win it.
Its fiscal 2019 results, , delivered Feb. 28, show the company continues growing 14% per year even as its original niche gets swallowed up by the cloud. Revenues of $8.9 billion brought net income of $2.4 billion, meaning over one-quarter of revenue hit the net income line.
Sweet.
VMware used its virtualization niche to build a cloud container solution that is second to none. Now an alliance with Microsoft (NASDAQ:MSFT) will end the virtualization war with Microsoft’s own competing system, Hyper-V. Microsoft wants VMware customers on its Azure cloud.
The result is that VMware is sitting where IBM was heading, a world where companies have both their own clouds and contracts with public cloud vendors. This is the “hybrid cloud.”
You want to own a piece of this, but how?
The Dell Solution?
VMware itself was originally a spin-off of EMC, which made data center hardware. EMC held 80% of VMware common. EMC was then bought by Dell Technologies in 2016, a deal that took Dell private. Then, late last year, DELL (NASDAQ:DELL) went public again, in a complex deal that still holds 80% of VMware,, but also the debt used to buy EMC.
Basically, DELL is the old EMC, now with debt — roughly $42.5 billion of it as of Feb. 2, but it does have that 80% stake in VMware. VMware opens for trade March 1 with a market cap of $70 billion, while DELL is worth $40 billion, making the value of all its other operations a negative $30 billion because of the debt.
Small wonder, then, that investors prefer to hold VMware even though, as part of the deal to take Dell public, it paid out a huge dividend in December — $26.81 per share. When Dell reported its earnings, also on Feb. 28, it showed $90.6 billion of revenue and almost $10.3 billion of Earnings Before Interest, Taxes, Depreciation and Amortization (EBIDTA), the big number private equity mavens love to measure. But the interest meant a GAAP loss of almost $2.2 billion, with non-GAAP net income of $5.2 billion or $1.86 per share.
Buyer’s Dilemma
Assuming interest rates don’t shoot up, DELL shares look like a great place to be, since you get 80% of VMware. But if interest rates rise, making it difficult for DELL to pay down that debt, then VMware is the play. Since Jan. 1, VMW shares are up 25%, while those of DELL are up just 14%.
It’s a lot like the pre-Dell situation, where VMware was a better investment than EMC despite EMC’s huge stake in VMware. The whole structure had been put together by former EMC CEO Joe Tucci, and the sale of it to Michael Dell and his private equity partners allowed Tucci to retire.
When DELL came public, Michael Dell was said to hold 206.5 million Class C voting shares, the same shares you can buy, but there are also privately-held Class A and B shares. Dell’s public shares should be worth about $11.3 billion. Most of his personal wealth is now in MSD Capital, which also holds interests in restaurants and hotels. Forbes estimates his fortune at $36.1 billion as of March 1.
The Bottom Line on VMware
As with its old EMC structure, you’ll get more “play” on your investment owning VMware shares but, ironically, more ownership with DELL shares.
History also indicates you’re better off in VMware. That’s where the big profits are. But the future of your investment is in the hands of DELL.
Dana Blankenhorn is a financial and technology journalist. He is the author of a new mystery thriller, The Reluctant Detective Finds Her Family, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in MSFT.
