EUR 850.00 For Business Accounts Only

Morningstar | VMware Poised to Become the Enterprise Network and Cloud Commonality; Raising FVE to $148. See Updated Analyst Note from 03 Aug 2018

After taking a fresh look at VMware, we are raising our fair value estimate to $148 per share from $107. We are maintaining our narrow-moat rating and increasing our moat trend to stable from negative. With shares trading around our fair value estimate, investor attention is warranted due to our expectation that VMware can capitalize on being the commonality between public cloud, on-premises, and private cloud infrastructures.

Most enterprises can benefit from public cloud services in some capacity and will utilize a mixture of private and public clouds, in our view. Complexities associated with integrating existing infrastructure and clouds can be alleviated through VMware's Cloud Provider Program and public cloud partnerships. Since most enterprises utilize and are familiar with VMware for machine virtualization, we believe firms would prefer VMware software in migrating workloads to clouds versus learning a foreign software stack provided by cloud providers. Large cloud providers, like Amazon AWS who want to drive cloud demand but lack on-premises or private cloud presence, see VMware as a method of increasing cloud utilization.

We opine that VMware's vast array of cloud provider partnerships, software design leadership, and existing customer base mass should facilitate customer retention as firms increasingly migrate toward clouds. VMware's support of containerization showcases a willingness to grow alongside a technology that could depicted as a competitive force. We expect VMware's movement into adjacent, high growth, markets of hyperconverged infrastructure, end-user computing, and software-defined networking to expand the company's consolidated revenue stream at a 9% five-year CAGR. Our expectation is that higher margin growth areas, including SaaS subscriptions, coupled with forecast operating efficiencies should expand VMware's operating margin profile into the high 20% range by fiscal 2023.

Dell, the majority-owner of VMware, announced its intention to return to the public market before the end of 2018 through a new Dell Class C share. The VMware tracking stock, DVMT, will be exchanged for Dell Class C shares or cash payments not to exceed $9 billion in totality. VMware's one-time special dividend of $11 billion, of which Dell receives 81%, will help finance shareholders electing a cash payment. After the dividend payment occurs, we may adjust our fair value estimate by approximately $27 per share to reflect the cash outflow.

VMware, a pioneer of virtual machines, dominates the maturing data center server virtualization market. Private and public clouds are becoming ubiquitous among enterprise networks as on-premises server virtualization apexes. After shedding its cloud provider business in 2017, VMware created a robust cloud provider partnership portfolio, which we think helps the firm handle the changing market landscape. VMware's next wave of growth should stem from software solutions for hybrid clouds, hyperconverged infrastructures, and network virtualization.

Our view of cloud networking, akin to VMware's assessment, is that most enterprises will utilize hybrid cloud solutions. Public clouds can precipitously augment network growth but enterprises face integration complexities between on-premises networks, private, and public clouds. Beyond hyperscale cloud provider partnerships, VMware's Cloud Provider Program offers thousands of cloud partners collaborating with VMware software. In our view, this allows VMware to remain ingrained within networks while becoming the commonality between private and public clouds.

Perhaps the biggest VMware investment risk lies within its ownership structure, as Dell Technologies owns 81% of the combined firm. VMware's pending $11 billion one-time special dividend will help Dell's buyout of its VMware tracking stock (DVMT). A different possible outcome was a Dell and VMware business combination, and we cannot rule out that possibility in the future. Our take is that VMware's operations can be viewed outside of Dell's balance sheet, but an underlying risk remains.

VMware's vSphere and ESXi hypervisor are virtualization gold standards, and the its hybrid cloud platform creates a unified view across multi-cloud environments. We believe VMware's hyperconvergence, network function virtualization, digital workspace and end-user computing products should keep VMware as a trendsetter. VMware's Kubernetes embracement and Dell's Pivotal ownership should provide growth with containerization. We opine that software cohesion across on-premises and clouds along with nascent networking trend products should give VMware sustainable growth.