When VMware (NYSE:VMW) reported third-quarter results in October, the virtual computing pioneer beat Wall Street expectations on both the top and bottom lines. But overseas sales came in a bit soft, and VMware shares fell more than 7% the next day. The stock is still trading in that new, lower range today.
That quarterly report is far from the latest news out of VMware, though. Company executives recently spoke at two major industry conferences, sharing plenty of fresh insights on what's going on.
Here are five of the juiciest nuggets from VMware's showings at the UBS Global Technology Conference and the Credit Suisse Technology Conference. For starters, you might be surprised to hear that VMware's management don't really mind these low share prices.
Say what? Low share prices are good?
At the UBS confab, inveterate analyst Brent Thill brought up VMware's strong cash reserves and wondered what the company might do with them. VMware CFO Jonathan Chadwick had a quick response:
We have just over $7 billion of cash and investments on the balance sheet. Around a third of that is located domestically with the rest obviously internationally located. I think that's a good position for us to be in and we have been active in our share buyback. We continue to do that.
Right now, to anticipate the next question, I don't think a dividend is the right use of our cash. I want to make sure we're returning any surplus cash to shareholders, but I also want to make sure that we've got enough fire power as we think about what is a pretty dynamic environment out there.
In other words, Chadwick likes to return cash to shareholders, but dividends are off the table for now. And low share prices obviously boost the efficiency of share buybacks. Under these circumstances, cheap shares can only help the company put its surplus cash to good use.
Chadwick didn't discuss this detail, but low prices also give investors an attractive buy-in window. The stock has traded sideways over the last four years while earnings more than doubled, so VMware's valuation has plunged from over 100 times trailing earnings to a P/E ratio just below 40.
What about growth drivers?
Chadwick also cast some light on how VMware plans to keep its sales growing over the next several years. It's all about adjusting to an IT industry in a state of massive flux. The company can't lean on its biggest traditional winners anymore:
Compute virtualization stand-alone vSphere is something that by design we are looking to de-emphasize. We're increasingly looking at compute being a technology embedded inside the vCloud Air, embedded inside the software-defined data center, and embedded inside our suites.
So as we think about how we talk about the business, it's no longer just about the hypervisors, no longer just about stand-alone vSphere, it's about the offerings going forward and those offerings beyond stand-alone vSphere are now greater than 50% of our total bookings. Total product bookings grew over 50% in Q2 and over 25% in Q3. So the strategy and the transition that we're embarking on and we've been under way with for now a number of years is actually performing as we would like it to. Clearly stand-alone vSphere by design is declining as we drive compute to be a core platform across the business.
So that's what's going on with software-defined data center.
This is the innovator's dilemma, writ large.
VMware helped pioneer the virtual computing model on which the modern data center is built. But resting on those laurels would be a quick ticket to bankruptcy, as the computing world has moved on to the next Next Big Thing.
VMware must kill its old darlings and embrace the new reality by building scalable systems and services that can be hosted anywhere the customer pleases. This is the new model, the "software-defined data center" that Chadwick spoke of, and VMware needs to find a role in the new market reality. So the old vSphere package is becoming an afterthought, a built-in piece of a larger product map, and isn't VMware's biggest growth driver anymore.
Steady as she goes
At the Credit Suisse conference, VMware CEO Pat Gelsinger noted that the strategy shift actually started two years ago, but that he has no intention of changing the tune now.
"When you lay [the strategy] out, about two years after, you're totally bored with it, you should be telling it for two more years," Gelsinger said. "I mean, it takes a while for you to be able [to] execute, build momentum behind it and we are seeing it resonate increasingly." He continued:
Now that we have products delivering in all elements of it, some of which we only launched a quarter or two ago. So we really feel like the strategy is right on. Customers are resonating with it. Our execution and momentum behind it is building up. The industry is understanding it and we're really quite excited about the next couple of years as we get it really implemented at scale in the market and with customers.
Gelsinger is asking investors for some patience, here. The software-defined data center vision is coming into focus at this point, with important components being only a couple of quarters old. Changing course again would be a terrible idea right now, as the next hockey-stick growth moment should be just around the corner.
Do keep in mind that it's VMware's CEO talking, here. It's his job to sell the business story, especially on a stage in front of analysts and investors. That being said, I think Gelsinger's analysis is spot-on. With next-generation computing models like OpenStack knocking on the door, and the rising tide of the Internet of Things poised to change the entire balance of computing demand, VMware's hybrid strategy ties into these trends rather than rejecting them.
Past performance is no guarantee of future results and all that, but I see VMware headed in the right direction.
Big hat, no cattle?
VMware doesn't stand alone in the software-defined data center space, of course. In particular, VMware rubs up against networking giant Cisco Systems (NASDAQ:CSCO) in many project bids. Cisco likes to claim that its Unified Computing System and 9K switches can outperform VMware's software-based solutions.
Gelsinger fought back with imagery straight out of the Wild West:
The customer, to execute the Cisco vision, they need a new piece of hardware called the 9K. They need to upgrade it with the new proprietary ASICs. They need to deploy the new ACPI technology and modify their applications to take advantage of it. So, my simple summary of Cisco is, I mean, there's a lot of rhetoric -- big hat, no cattle -- because customers aren't deploying software-defined networking with Cisco today. They're deploying Cisco 9K switches and that's what they talk about.
Cisco's high-end 9k switch does indeed use specialized hardware to deliver its bits, albeit managed by a flexible software system. I leave it up to the reader to decide whether that qualifies as a pure software-defined networking solution, and whether that definition makes a difference to real-world performance and systems management.
Later in the call, Gelsinger also acknowledged that many VMware installations actually run on Cisco hardware today, since VMware isn't in the business of selling physical machines. So, it's not a battle to the death, but two partners jockeying for larger slices of the end user's ordering pie.
But it's fun to see executives reaching deep into their bags of colorful language. Gelsinger certainly delivered there, and gave investors something new to think about.
The real competition
Cisco is more of a sparring partner than a serious head-to-head VMware competitor. Where, then, does Pat Gelsinger see the title fight happening?
In the public cloud market, of course. Gelsinger said clients have flocked to public cloud solutions en masse over the last couple of years, and VMware is one of the leading providers of these services.
"We've said the four big players that we think matter for the long term are Amazon.com's (NASDAQ:AMZN) AWS, Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG) (NASDAQ:GOOGL), and VMware, and there isn't a fifth at that layer," said Gelsinger. "It's people who can build big software-driven cloud environments for the future. Against Amazon and Google, the VMware strategy is to focus on three things, focus on the enterprise, focus on hybrid value, and enable a rich partner ecosystem to deliver that value into the industry."
If you think about enterprise and hybrid, they clearly differentiate us from Google or Amazon. Microsoft has the closest strategy to ours but they're really approaching it from an app-centric way, building on Office 365 and really extending those categories into customers versus building an extension of the data center at the infrastructure level, which is the VMware strategy. The partner ecosystem is the one that is dramatically differentiating for VMware.
That's perhaps the clearest description I've seen of what sets the major public cloud players apart from one another. Jeff Bezos might disagree with Gelsinger's view of the enterprise cloud market, but what really matters is how corporate customers look at the market.
I do believe Gelsinger is on the money with his lineup of Four Horsemen, at least at the moment. Keep an eye on these four companies to see how the public cloud market evolves -- and always look out for upstarts or transformed veterans coming up from behind.