Determining price action from an earnings report is sometimes tricky business. Case in point is cloud computing specialist VMware (NYSE:VMW). Immediately following its surprising per-share profitability and revenue beat for the third quarter of fiscal year 2020, VMW stock jumped. However, as investors carefully digested the news, sentiment for VMW deteriorated.
At first glance, the volatility in VMware stock following the Q3 disclosure is hardly intuitive. Prior to the report, analysts had a consensus target for earnings per share of $1.43. However, actual EPS came in at $1.49, a positive surprise of over 4%.
On the revenue front, VMware rang up $2.46 billion. This notably exceeded analysts’ estimates calling for $2.41 billion by a wide 2% margin. Optically, the top-line sales tally substantially outpaced the year-ago quarter’s haul of $2.2 billion. So, how come VMW stock failed to reflect these bullish implications?
Despite exceeding targets for key metrics, the result wasn’t entirely impressive. For instance, the tech firm delivered EPS of $1.56 in Q3 fiscal 2019. From that angle, VMware stock is a less profitable entity.
More importantly, though, the beat largely came from VMware’s cybersecurity firm Carbon Black acquisition. As The Motley Fool’s Keith Noonan reported, the buyout closed on Oct. 8. As a result, the deal unexpected added $10 million to the top line for Q3. But without the acquisition’s impact, VMware’s sales tally would fall about $5 million short of analysts’ expectations.
Of course, the Carbon Black buyout is critical for VMW stock because it aligns with the underlying company’s cloud ambitions. Synergies are already in place between Carbon Black and Dell, with the latter a majority shareholder of VMW.
Still, some tough questions remain.
Kubernetes Is the Future, but Will VMW Stock Be There Too?
To understand the long-term thesis of VMware stock, one must understand Kubernetes. And to understand Kubernetes, you must appreciate the containers dominating the cloud narrative.
This is by no means a comprehensive analysis of the cloud; merely, a quick summation. However, it’s necessary to get some background on cloud mechanisms to grasp why some investors are dumping VMW stock.
Currently, many cloud developers are rapidly adopting containers. As the name suggests, containers are self-contained ecosystems featuring applications and the various files to run them. This latter point is critical because in prior computing protocols, sharing a program meant running on various guest operating systems.
What if the person you’re sending an application to doesn’t quite have the OS configuration that you have to run the application? With containers, this problem is solved because the operational mechanisms to run the app is also included.
And with this setup, a company like Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) is able to run myriad apps across uncountable operating systems. But managing these various containers is a tremendous hassle. Thus enters Kubernetes, which automates the distribution of these containers. For our purposes, you can look at it as artificial intelligence-driven containers.
VMware’s management team recognizes Kubernetes as a paradigm-shifting tech innovation, particularly for big enterprises. Therefore, the company is forging ahead with developments in this arena, theoretically bolstering VMW stock.
I say theoretically, though, because Kubernetes is a complicated beast. An open source platform from Alphabet, no set standard for this cloud protocol exists. Thus, a cloud company can do more damage to itself than good if they release a Kubernetes-based platform haphazardly.
Moreover, you can’t just do Kubernetes on a whim. Implementation requires time and money. As such, many investors are turning skeptical on VMware stock.
Exercise Proper Tactics on VMware Stock
Another related issue clouding the narrative for VMW stock is competition. So far, the credible Kubernetes players are the big dogs like Alphabet’s Google or IBM (NYSE:IBM).
One of the fears that stakeholders have is that Kubernetes is most appropriate for large organizations and those expected to grow bigger. Therefore, the enterprise-level cloud specialists have a substantial advantage with this innovation. Specifically, IBM has invested years and billions of dollars to achieve a dominant position with Kubernetes; hence, the company’s Red Hat acquisition.
It’s looking like a market for the high rollers, which explains why VMW stock is seeing red ink.
That said, VMware offers an interesting take on a still-burgeoning cloud industry. Personally, I’m curious how high this company can go. Yet I would exercise caution with VMware stock. Let the immediate bearishness fade, then consider adding a position, especially if it breaks down into $130 territory.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
