Thoughts on VMWare (VMW) and EMC Valuation

/ Adam Nash

I’ve been resisting any comment on this topic, but I just had to note something.

VMWare, after its IPO at $29 per share, crossed over $100 today to close at $101.61. Since they have 383 Million shares outstanding, that’s a market cap of $38.91 Billion. EMC closed at $21.81, and with 2.1 Billion shares outstanding, their market capitalization is now $45.75 Billion.

On the surface, that looks like a generous valuation for EMC. P/E of 26 on 2008 earnings projection, which is more than double their 5-year expected growth rate of 12%.

But, let’s factor out a few assets here.

They have over $4.5B in cash. They also hold a 87% stake in VMWare, which at today’s close, is worth $33.85 Billion.

So that means, you are basically buying all of EMC right now for $7.4 Billion, which gets you a $12B+ revenue business with a net margin of 10.8%.

That just doesn’t make any sense, on its surface. My guess is you are seeing two factors at play here:

  1. There are liquidity issues with VMW, which are pushing up the valuation artificially. No options, no real shares to short. As a result, the EMC valuation is discounting the VMW stake to a more realistic value.
  2. VMW valuation is being driven largely by large consumer interest, and that interest just isn’t doing the math on EMC which is broadly held by professional investors and indexes.

Personally, my trade in this area has been a winner, but still disappointing. Since I couldn’t get VMW IPO shares, I used a put spread (Jan 2009) on EMC, 17.5 and 25, to capture value as EMC appreciated, and to generate the cash to buy EMC 17.5 calls at a 10:1 ratio of my desired VMW position. I closed out the put spread last week, and now just have the calls which are deep in the money. Overall, the position has returned 80+%, which is great, but doesn’t quite capture the 300% return of VMW post-IPO. Of course, this is because it’s clear that EMC was pricing in the IPO in the run-up from 12 to 19 ($14B worth) from the Feb IPO announcement.
So the only question remaining is, when will VMWare be worth more than EMC? 🙂