EMC's Holy Grail

During the past year, EMC Corp. (NYSE: EMC  ) has transformed itself into a different company -- which was critical, given that its core business of hardware storage has been ailing. The transformation has been done with its cash hoard and stock, as the company purchased Legato Systems in July for $1.3 billion and Documentum in October for $1.7 billion.

This week, EMC struck again and purchased VMware Inc. for $635 million in cash. Founded in 1998, VMware is a leader in server virtualization. This is software that turns one server into essentially different machines, with each able to run is own operating system (such as Windows, Unix, or Linux). In other words, companies can maximize their existing IT resources.

It appears that VMware has a significant technology lead in this emerging market. In fact, the company has been cash-flow positive for two years and is expected to ramp revenues from $100 million in 2003 to $200 million next year.

Interestingly enough, VMware goes beyond storage, which opens up heavy competition from IBM (NYSE: IBM  ) , Sun Microsystems (Nasdaq: SUNW  ) , Hewlett-Packard (NYSE: HPQ  ) , and Microsoft (Nasdaq: MSFT  ) -- which, by the way, tried to buy VMware last year. While EMC planned on making the acquisition in the middle of 2004, it moved now because VMware is experiencing a high degree of traction in its business.

On the face of it, VMware's technology is not really new. Virtualization has been a part of the mainframe world since the 1960s. But VMware has figured out how to make it work on Intel-based servers, which continues to be a strong market.

With the VMware acquisition, EMC will derive about half its revenues from software. It's not often a company of this size can make such a radical change in its business. Perhaps that is why CEO Joe Tucci calls his new vision the "Holy Grail" for IT.

Tom Taulli is the author of six books on investing, including Investing in IPOs (Bloomberg Press), as well as a professor of finance at the USC School of Business (don't worry, but he does come out of his ivory tower). You can reach him attom@taulli.com.