It's been almost one month since VMware (VMW +0.00%) announced its results for the fourth quarter, upon which investors sent the stock plummeting 20%. While the report itself was good, the Street absolutely hated the company's outlook. Accordingly, VMware's story has turned from strong growth to valuation, and the latter is beginning to dominate headlines. But when will this bleeding stop? And has VMware approached value territory?
Amid much pressure, will there be growth?
Investors are rattled that management is calling for only 15% growth for all of 2013, which is 3% less than Street estimates. Likewise, single-digit growth in licenses doesn't excite anyone, especially not when the stock was (then) trading at a P/E of more than 70. And making matters worse, investors won't see any progress until the second half of the year. I've had my doubts about VMware for quite some time. Nor have I been that ecstatic about the future of the virtualization industry.
However, VMware still wants to be a force. While management's guidance didn't imply an immediate slump, it didn't give investors the impression that it knows where its next growth opportunity is going to come from. Market share erosion has finally arrived. And the dust has yet to settle. With the stock having reached a low of $70.05 last week, shares are down an additional 9% -- bringing the decline to (roughly) 30% since the earnings report. The beneficiary of all of this has been Citrix (CTXS +0.00%), which, during all of VMware's struggles, is up 10%. And this is not by coincidence. Citrix is siphoning off business from VMware. And the company's recent earnings, which included 17% jump in product and license revenue, are evidence of that.
For VMware, that roughly 65% to 70% of its addressable server market is already virtualized is a major concern. While this speaks to exceptional market share, it also means it has saturated its core products. Back to VMware's guidance for moment: It could be that management is just being too conservative, given that enterprise IT spending is not yet back to its glory levels. But the question is, if/when it does return, where does virtual desktop infrastructure rank on the list of CIOs' priorities? And let's assume it's higher on the list than VMware believes -- price is still going to be an issue going forward.
To that end, Citrix's XenDesktop, which in most cases, requires 50% less in enterprise capital expenditure, is still the winner. Plus given enterprise's increased demands for security due to the increase in mobile devices, Citrix's partnership with Cisco gives it an added advantage here, too. Meanwhile, other rivals such as Red Hat are beginning to gain traction. And it certainly doesn't help that Microsoft (MSFT 0.95%) offers a free alternative to VMware's vSphere called Hyper-V, which is essentially an extension to its System Center ecosystem.
Microsoft, which always had its own virtualization ambitions, takes an "expansion" approach, which makes more sense. This means Microsoft does not have to reinvent environments that are already running Windows or its System Center (no need to reinvent the wheel). Conversely, VMware's model utilizes a collection of appliances with various capabilities that work independently. And although VMware's platforms are arguably better (in some cases), the cost remains an inhibitor. While VMware can choose the revenue growth path and lower its prices, long-term this may not matter. The company will still have to address new markets. In the meantime, investors can't be pleased about the company's swift lack of leverage.
You watch my back, I watch yours
It's uncertain when this bleeding will stop. But it's clear that VMware needs a partner, specifically, one that can help offset its mobile deficit. I think Oracle (ORCL 1.26%), which just acquired Acme Packet, would be a good start. This should help VMware offset Citrix's advantage with Cisco, while also helping Oracle strengthen its enterprise one-stop-shot strategy against Cisco and Microsoft. Plus, both VMware and Oracle already share similar interest in the software-defined networking market. So it doesn't seem unreasonable to think that an agreement can emerge. But clearly the urgency is one-sided.
