What a summer it's been for our scorecard at Motley Fool Rule Breakers! Many of our top picks are down big from our buy-in prices. Few, though, have taken the sort of beating Mr. Market has delivered to VMWare (NYSE: VMW ) , down more than 47% since David Gardner picked it for the June issue. The problem, as I understand it, is competition from Microsoft (Nasdaq: MSFT ) and the sudden departure of VMWare co-founder Diane Greene.
"I believe that Miss Greene was 'finally' forced out by a board that all has ties to EMC (NYSE: EMC ) ... Factor in the increasing competition from Mr. Softy, and this one could get real ugly, real fast," CAPS player TMFBreakerWade wrote in support of an 'underperform' call he made earlier this month.
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Fair enough. During the company's conference call with analysts, new CEO Paul Maritz, a Microsoft alumnus, spoke to both investor concerns. But he spent far more time addressing Mr. Softy than Ms. Greene.
"I know that Microsoft is a formidable but not invincible competitor, I know that Microsoft can't afford to play a long waiting game," Maritz said. "But I also know from firsthand experience that where a competitor has a lead, and that competitor invests and innovates to stay ahead and to keep changing and raising customer value proposition, they can be very hard to catch even for Microsoft."
The message? Expect VMWare to keep investing in research and development -- more than 25% of revenue in the just-completed quarter -- and be aggressive in defending its turf. Maritz's strategy includes developing tools that make virtualization easier and more effective than it otherwise might, using Microsoft's alternative. Here are three reasons it'll work:
1. Webification. My apologies for the made-up word; I use it here to illustrate the importance of virtualization to cloud computing, otherwise known as software accessed via your browser, rather than installed and managed on the desktop. Imagine the moving parts involved in getting Web content to you -- the sort of grunt work that Akamai (Nasdaq: AKAM ) and Limelight Networks (Nasdaq: LLNW ) perform daily -- and you'll understand how complex a job it is to take a group of servers, connect them to the Web, and then slice their parts into usable chunks for optimum data delivery. VMWare still performs this high-wire act -- increasingly important in a Web-connected world -- better than anyone.
2. Specialization. Tech has birthed a number of well-funded generalists since the early days of the personal computer. Yet specialists still dominate certain markets, including Intuit (Nasdaq: INTU ) in personal-finance software, and Oracle (Nasdaq: ORCL ) in databases. Highly technical jobs often demand expertise that a generalist can't provide. Here, VMWare is the specialist.
3. Virtualization. Microsoft is an unabashed generalist, with an astounding track record in desktop software. And that's a problem: Mr. Softy's cloud computing strategy -- known as "software plus services" -- betrays a desktop bias that isn't likely to help its effort to unseat the cloudier VMWare. The thinking, as I understand it, is that the cloud and the browser isn't enough to support great software; users also need desktop access. To me, this approach sounds logical in the sound-bite sense -- "yeah, sure, software plus services" -- but, technologically, could add the sort of complexity that IT managers loathe.
Microsoft is a serious competitor, and Maritz is smart to watch his back. But I seriously doubt that the threat from Mr. Softy and others is so fierce that shares of VMWare should trade near a 52-week low. The implication? This business is no longer what we thought it was.
Perhaps not, but demand is still high. The biggest change -- and it is huge -- is that the guy who helped to write Microsoft's playbook for killing upstarts is now working for the other team. How bad can that be?