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VMware Inc. Steps Into an Uncertain Future

By Demitri Kalogeropoulos – Oct 21, 2015 at 7:37PM

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Third-quarter earnings were strong, but the buyout of EMC should bring significant growing pains next year.

Cloud-services provider VMWare's (NYSE: VMW) status as an independent company survived this month's news that its parent company, EMC (EMC), will be taken private and become part of Dell. Yet the landmark deal still promises to bring major changes to VMware's business beginning next year. The tech company discussed those likely shifts, along with its latest operating trends, in the third-quarter earnings results posted on Tuesday afternoon. Investors were not pleased and had sent the stock down by more than 20% as of 1:40 p.m. Wednesday.

VMware results: The raw numbers


Q3 2015 Actuals

Q3 2014 Actuals

Growth (YOY)


$1.67 billion

$1.52 billion


Net Income

$256 million

$194 million






Source: Yahoo! Finance.

What happened with VMware this quarter?
VMware's results showed strong overall growth, with rising profitability and surprisingly robust sales. Here are the key highlights:

  • License revenue improved by 11%, to reach $681 million. That growth was an acceleration over the prior quarter's 9% boost.
  • Hybrid cloud and software-as-a-service revenue jumped 50% higher year over year, and now comprises 6% of all sales.
  • Operating income spiked higher by 35% as corporate expenses dove as a percentage of sales.
  • As a result, operating margin rose to 31.5% of sales from 30.4% a year ago.
  • Operating cash flow was $421 million, down from last year's $606 million, but an improvement over the prior quarter's $316 million result.
  • Cash on hand rose to $7.2 billion from $7.1 billion last year.
  • Management spent $200 million on stock buybacks and has more than doubled its repurchasing pace through the first three quarters of the year.

What management had to say
Executives were happy with the overall results saying they "reflect VMware's strength in delivering extraordinary value to our customers," according to CEO Pat Gelsinger. The company was pleased with the most-recent VMworld conference, which hosted more than 30,000 customers and partners, and served as a platform to announce new product offerings and a major refresh of its cloud-management services.

And management believes that positive momentum will only be enhanced by the landmark deal to take EMC private. "We are very optimistic about the long-term value to VMware of the Dell and EMC plans to merge and the formation of the Cloud Services Business," Gelsinger said. The cloud-services unit announced Tuesday will be jointly owned, split 50-50, by EMC and VMware. It will include the vCloud Air, and Virtustream products, along with object storage and managed cloud services -- all under a single Virtustream brand. Results for Virtustream will be included in VMware's results starting in the first quarter of next year.

Looking forward
Investors will want to watch how this deal impacts VMware's long-term growth and profitability potential, given the stiff competition Virtustream will face. Management gave its first reading of that change on Tuesday, and it includes at least a short-term hit to operating metrics. They forecast profit margin of roughly 28% in 2016, down significantly from the 32% that they expect to achieve this year.

Meanwhile, sales growth for the larger enterprise should be in the high-single digits or low-double digits in 2016. Again, that's slightly below the 10% to 13% growth that VMware is booking on its own in 2015. It's likely that those expected growing pains are what's behind the pressure on the stock Wednesday.

Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool recommends VMware. 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.

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