Our Top 5 Tech Stocks for 2011: EMC

This article is part of Our Top 5 Tech Stocks for 2011 series.

If you're like me and spend most of your time scouring technology stocks but find stocks with a strong presence in cloud computing a bit too pricey, I think I've got just the right play into the field. EMC (NYSE: EMC  ) stands to benefit from explosive data storage trends, but it also has a powerful cloud computing kicker thanks to its massive stake in VMware (NYSE: VMW  ) . While cloud computing stocks trade for nosebleed levels, EMC on its own isn't terribly expensive. However, after considering its stake in VMware, it's downright cheap.

EMC stands as the kingpin of networked storage, the kind of storage that's growing in popularity along with virtualization. However, It's not alone in the space, battling such large competitors as IBM (NYSE: IBM  ) , Hewlett-Packard (NYSE: HPQ  ) , and Dell (Nasdaq: DELL  ) in addition to smaller storage peers like NetApp (Nasdaq: NTAP  ) .

Get ready for the storage rocket ride

One only needs to look at the headlines to see how hot storage is. Between these massive players, deals are flying left and right, with the most recent buyout being Dell's $820 million offer for Compellent (NYSE: CML  ) yesterday. There are a couple reasons for the buyout mania sweeping the industry:

  1. The amount of data being created is outstripping our ability to store it: The Economist estimates that the amount of information created each year is growing at a 60% compounded rate. What's even more impressive is the divergence between information created and the available storage capacity. While the two largely tracked each other up through 2007, information is now being created at an exponential rate that should be more than double the available storage by 2011. As EMC proudly points out, information is expected to grow 44 times over the next 10 years thanks to these consistent high rates of growth.
  2. The nature of storage is changing: While storage used to be defined by hard disks serving very specific purposes, today's storage is at the center of cutting-edge technology. Areas like virtualization and scale-out storage allow for better utilization and overall capacity, while other technologies shift necessary data between faster (and inherently more expensive) drives and cheaper drives for performance gains. Companies that fail to develop in key areas need to buy smaller players to fill in their product portfolios.

While this kind of extreme innovation can sound daunting, the important thing to remember is that EMC has not only some of the best foundational software in storage, but it also has several different software components that become vital to data centers buying from EMC. Also, after a couple of recent purchases, EMC has the most filled-in storage portfolio of all the major players.

While the moat here might not be as wide as a company like IBM that controls end-to-end facets of data centers, EMC's focus on storage's emerging growth areas has allowed it to take market share from larger players like HP and Dell while those companies consolidate across other segments of the IT industry.

What really gets me excited
At this point, EMC might not sound terribly exciting. It's the leader in a growth industry that should see compounded double-digit sales growth through mid-decade, but it trades for a P/E approaching 30; hardly the kind of skintight P/E to get your heart racing.

However, a key component to the EMC story is its history in virtualization. You see, in early 2004 EMC completed its acquisition of virtualization pioneer VMware for $625 million. Since then, EMC has spun off a portion of VMware, but it still maintains close ties and an 80% stake in the company.

When you consider that VMware is now worth more than $37 billion, that means EMC's stake in VMware comes out to nearly $30 billion. Since EMC itself only has a market share of $46 billion, that means its business is only worth about $16 billion after netting out its VMware holdings.

Given the outsized value of its VMware holding, you'd expect EMC to soar along with VMware's stock, but a wide gap has actually broken out between the two companies. In the past year, VMware more than doubled while EMC saw 27% gains. That's a respectable rise, but it clearly shows that investors aren't giving the EMC full credit for its vast holding in VMware.

Source: Capital IQ, a division of Standard & Poor's.

More to the point, EMC's most direct competitor, NetApp, trades at multiples well above its larger rival. To be sure, NetApp has navigated the economic downturn strongly and has executed well in a number of growth areas, but the company still trades for nearly 22 times trailing cash flow. Compare that to EMC -- which after netting out its VMware stake and removing the results of VMware from its financial results -- trades for less than 10 times cash flow. Yet, as you can see from the chart below, NetApp has run far above EMC in recent months as well.

Source: Capital IQ, a division of Standard & Poor's.

Top-shelf storage on sale!
The bottom line here is that even if you only give EMC credit for half of its VMware stake, it's still trading at a steep discount to its closest peer despite being an industry leader. That's a compelling deal, even if VMware were to suddenly fall from its seemingly never-ending climb.

While I personally find many cloud-computing stocks overvalued, EMC gives a way for investors to get exposure to the fast-growing segment while still hanging on to an industry stalwart like EMC that should be stable and continue to excel in the years ahead. Best of all, if you find VMware overvalued, you can always hedge any potential cloud computing collapse by either buying put options on VMware while purchasing EMC stock -- or for the truly brave -- short VMware while buying EMC.

With options aplenty for buying EMC no matter your view of cloud computing, it's time to give EMC a try for your 2011 tech portfolio.

Do you agree? Share your thoughts in the comment box below.

To access the full list of Our Top 5 Tech Stocks for 2011, click here.

Eric Bleeker owns shares of no companies listed above. VMware is a Motley Fool Rule Breakers pick. The Fool owns shares of International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (50)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 14, 2010, at 12:44 PM, TerenceFL wrote:

    There's one moderate-level danger for EMC and VMware; there are alternatives available for *free* that are gaining market share. Microsoft now ships their Hypervisor with Windows Server. These trends will continue to put serious pressure on VMware's product pricing and margins.

  • Report this Comment On December 14, 2010, at 1:14 PM, TMFRhino wrote:

    Hey Terence,

    I'd definitely agree that exists. I'd like to follow up on the article with more thoughts on VMware itself, but from talking with IT professionals I think the switching costs for VMware are surprisingly low. That's why it's probably best to assume something more conservative like a situation where EMC gets credit for half of VMware's value. However, even then they're selling at a pretty attractive (for the space) ~13-14X FCF multiple. That's a bit higher than some other high tech peers, but their end market is also one of the most attractive.

    Thanks for the post,

    Eric

  • Report this Comment On December 14, 2010, at 2:10 PM, hiddenflem wrote:

    how about going long emc and shorting vmware as an option if you think emc is the component that is most undervalued?

  • Report this Comment On December 14, 2010, at 2:35 PM, TMFRhino wrote:

    Hey hiddenflem,

    Suggested that very option in the conclusion

    "While I personally find many cloud-computing stocks overvalued, EMC gives a way for investors to get exposure to the fast-growing segment while still hanging on to an industry stalwart like EMC that should be stable and continue to excel in the years ahead. Best of all, if you find VMware overvalued, you can always hedge any potential cloud computing collapse by either buying put options on VMware while purchasing EMC stock -- or for the truly brave -- short VMware while buying EMC."

    Best,

    Eric

  • Report this Comment On December 14, 2010, at 3:56 PM, hiddenflem wrote:

    oh thanks, I missed that! have been thinking about doing that play for a few years now...

  • Report this Comment On December 14, 2010, at 6:04 PM, TMFRhino wrote:

    Probably a good thing you've held off with how VMW's been running as opposed to EMC. :)

    If you don't want to risk too much, the options play is always viable. Although, if your theory is that cheaper options from MSFT/CTXS/etc. catch up, always tough to nail down a timeframe (within an options play) when they could see some business decline from this competition.

    Best,

    Eric

  • Report this Comment On December 14, 2010, at 6:32 PM, seandoc wrote:

    How come we never got a buy signal on EMC when it was trading at 10 dollars,or VMW when it was 26.They both have their European headquarters 1 mile from where I live.I bought both on the basis that cloud computing was the next big thing,and EMC had a big stake in VMW.

    Not very technical but successful.

  • Report this Comment On December 17, 2010, at 11:10 AM, TMFRhino wrote:

    Seandoc,

    Wish I'd been around when EMC could have been had for $10 earlier in the decade. Then again, they didn't have the virtualization assets they have today back then.

    Good call on VMW though. I was only brave enough to thumb up it in CAPS, which you know, doesn't pay off as well. :)

    Best,

    Eric

  • Report this Comment On December 17, 2010, at 6:20 PM, Stimulant wrote:

    Dear Eric,

    I might have missed your point entirely, but It seems to me that you are, sort, off sayng this:

    ' People have not credited EMC enough, for having 80% control of VMW - its most important business segment and a very expensive stock,

    Thus, EMC is a good buy, even if you think that VMW is overpriced, and in fact you can buy EMC and even short VMW. '

    If I know anything about the stock-market (which I am not sure I do), is that this is the kind of dangerous advice to steer-away ecticly from.

    For, the credit that is not given to EMC (and its stock) for owning VMW (which is so expensive now), will, you can bet on it, be credited to EMC when its VMW unit loosses inflated air (which is the logic for shorting it, right?) and the EMC stock will plummet, as soon as VMW does, and with a potential "overshoot", as opposed to the current "undershhot" of its value.

    Please forgive my foolish thinking.

  • Report this Comment On December 20, 2010, at 1:28 PM, TMFRhino wrote:

    Hey stimulant,

    I think a key factor here is that I think EMC is a good business on its own. I think a great case scenario is the "give EMC half credit for VMW" scenario laid out above, in which case it trades at a 13-14X multiple FCF multiple, which is pretty attractive relative to its peers and industry growth.

    I find it highly unlikely that the company would overshoot any reaction to VMware. VMW losses could definitely drag the stock down, but as its hasn't reacted as much as it theoretically should have on the way up, it's highly unlikely you'd see any outsized move to EMC on the way down. That's in part protected by the company's excellent ability to generate cash. Also, as the company's (artificially high) P/E began to drop, you'd likely see buying.

    For me, while you could potentially see some choppiness around this, I like EMC's prospects over the next few years, even if VMware is worth half of what it is today. The possible catalyst of investors taking note of the discrepancy between the two stocks price movements is icing on the cake.

    That being said, I don't find your thinking foolish at all. There's always risks with these kind of plays. Especially if you short VMW and it keeps rising at an outsized pace relative to EMC.

    Hope that answers your question!

    Best,

    Eric

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1399459, ~/Articles/ArticleHandler.aspx, 10/25/2014 12:39:46 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement