Chief Technology Officer Jeremy Phillips asks Senior Technology Analyst Eric Bleeker in this video why his opinion on VMware has changed to the point he now believes the company is a strong buy. First off, Eric notes that valuation concerns around the company are abating. VMware is off more than 20% from where it traded at in early April, which makes the company a more compelling value.
Eric's main concern with VMware has typically sided with the crowd that argues the company was too expensive. He instead preferred getting exposure to VMware through "cheaper" parent company EMC, which owns 80% of VMware.
However, as VMware itself continues posting impressive results, it now trades at less than 20 times cash flow in spite of its huge P/E, which sits over 50. The imbalance in VMware’s cash flow and earnings stems from long-term agreements for maintenance and support that see revenue recognized between one and five years away.
Where does this show up? Last quarter, VMware licensing grew 11%, a number that was lowered from tough conditions around global IT spend. But because VMware is constantly recognizing long-term maintenance and support revenues booked up to years ago, when the IT environment was healthier, its support revenue was up 34%. This unearned revenue isn't something that's fully observable on the income statement, but it provides VMware with a nice cushion when the IT environment contracts like right now. VMware's not alone in this; almost every cloud and large IT play has similar arrangements. And to be sure, the ability to collect this revenue isn't riskless. But on the margin, Eric believes it makes companies like VMware much cheaper than they look. To see Eric's full thoughts, watch the following video below.
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Eric Bleeker and The Motley Fool own shares of EMC. Jeremy Phillips has no positions in the stocks mentioned above. Motley Fool newsletter services recommend VMware. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.