VMware (VMW +0.00%) has been a dominant force in the virtualization/cloud industry, but the stock has been taken to the woodshed lately, losing as much as 20% following its Q4 earnings report.
While the numbers from VMware were generally good, management incited fear with a gloomy outlook and essentially placed a bull's-eye on the others within the sector. This now makes Citrix (CTXS +0.00%) and interesting stock to follow. But let's not get carried away. While this sector's stocks often trade in parallel, it doesn't mean that VMware's struggles will have anything to do with Citrix or even Red Hat. But it does raise questions about which one will outlast the other.
Not all virtualization is the same
While the cloud and virtualization market is still doing well today, it's not expected remain at its robust levels forever. The question, though, is at what point the market will show that it can no longer support all of the names? At some point, there will be saturation. It happens in every industry. And if VMware's guidance serves as any indication, management has legitimized that concern. Has saturation arrived? If not yet, these numbers suggest it could be around the corner.
For instance, although bookings arrived solid, VMware's license billings were uninspiring at 7%, marking the second consecutive quarter of single-digit growth following Q3. It also wasn't a good sign that accounts receivable surged 30% to $1.1 billion. While this can be viewed as a positive in that it represents revenue, albeit deferred revenue, it also suggests a backlog in payments, which can impact cash flows. However, management killed hope by projecting 3% less growth for all of 2013 versus 2012.
What's more, not only did these projections imply single-digit license revenue growth, but investors have to wait until the second half of 2013 to see numbers they can truly get excited about. And for a stock that is trading at 25 times earnings per share of $3.17, the Street showed no mercy and shares got hammered. Meanwhile, Citrix saw its stock drop 7% following the assault on VMware's stock.
Cooler heads eventually prevailed. Not only has Citrix recovered those losses, but the company has added an additional 3%, lending support to the idea that VMware's problem does not have to translate to Citrix. It seems investors have begun to put two and two together and have arrived at the most logical conclusion: Citrix is expected to steal market share from VMware. At least, according to VMware's guidance, that's what the company believes. And as evidenced by Citrix's strong 17% surge in product and license revenue, the momentum is certainly there.
Also impressive was that Citrix was able to grow revenue from license updates by 22%. This means that the company has a healthy pipeline of recurring business, an advantage that can help Citrix offset the type of near-term headwinds that VMware is beginning to anticipate. In that regard, VMware is also being outperformed by Red Hat, which grew its license revenue by almost 20%. Given so many mixed signals, it's anyone's guess as to where this sector is heading.
Reading the writing on the wall
However, Citrix is not leaving it up to fate, not when enterprises are just beginning to get serious about moving real applications to the cloud. Citrix's acquisition of Zenprise, a mobile device management company, shows how badly Citrix wants to differentiate itself from VMware and Red Hat. So far, it's working.
Citrix said the deal will help the company's efforts to develop a complete mobile suite that includes GoToMeeting, Podio, and ShareFile. In other words, Citrix just established a mobile niche. This is brilliant for several reasons. For instance, even though the virtualization business is strong today, as noted above, it can't last forever. While we've cited the issue of saturation, the other concern is the very product that gets virtualized: the personal computer.
However, we keep hearing that PCs are dying. And there's plenty of evidence to suggest that this is no longer just a myth. Inevitably, once PCs are all laid to rest, what will be left of the virtualization business? Any guess? Oracle, which competes on several levels with Citrix, certainly figured it out when it acquired Acme Packet, which has one of the best mobile strategies for the enterprise.
This is what Citrix has figured out, and thus, its acquisition of Zenprise, which specializes in mobile device management, or MDM. Mobile devices have already begun to replace desktops and in many cases and are able to do the same things. Citrix will be able to support this new mobile trend while providing full security and other controls. Meanwhile, VMware, although it is still the market leader, has no such recourse.
Although VMware's Horizon Suite has some similar tools, it is not on par with Zenprise. And if VMware does not immediately address this area, it will find that it has fallen off the totem pole. Plus, with Citrix's relationship with Cisco, the company has a dominant hardware player that it can use to leverage enterprise services, while helping customers lower costs. All of which can help Citrix apply margin pressure to both VMware and Red Hat.
Time to bet long on Citrix
Without question, virtualization and the cloud will remain a critical IT priority for the long term. However, there are also signs that the industry can't support all of the players vying for the business. For that matter, we haven't even addressed Microsoft, which, although has a great relationship with Citrix, also has its own virtualization ambitions.
Nevertheless, as a betting man, my money would be placed on Citrix. Although the stock is far from cheap at a P/E of 40, shares are still undervalued when compared to VMware and Red Hat. Plus, if this company can continue to post revenue growth in the low 20% range and cash flow growth at 33%, these shares can reach $85 by the second half of the year; representing a 15% premium from current levels.
