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Morningstar | VMware's Strong 2Q Led by Growing Hybrid-Cloud Business; Raising FVE to $151

VMware reported strong fiscal second-quarter 2019 results and increased its fiscal 2019 guidance for revenue, licenses, non-GAAP operating margin and EPS, and free cash flow. We are encouraged by VMware's solid growth in hybrid cloud-based environments, network virtualization, hyperconverged infrastructure, and end user computing. Based on growth within critical focused areas, we are raising our fair value estimate for VMware to $151 per share from $148. Shares are trading around our fair value estimate for this narrow-moat firm, and we believe investors should seek a wider margin of safety.

Total revenue for the second quarter increased 13% year over year to $2.2 billion, and operating income increased 20% to $509 million. License revenue increased 15% to $900 million, and the Virtual Cloud Provider Program experienced 30% growth year over year. Hybrid cloud subscriptions and software as a service is now 10% of total revenue, and we believe VMware's strategic focus of integrating the on-premises, public, and private clouds is gaining momentum. Management commented that vSAN license bookings grew 70% year over year, and nine of VMware's largest 10 deals included end user computing and NSX for network virtualization and security.

Management's increased guidance came in above our expectations for the remainder of fiscal 2019 and now expects total revenue growth of 12.2% year over year. VMware is producing positive results within its focused growth areas and is in a strong position to capitalize on hybrid-cloud environments gaining popularity, in our view. We opine that enterprises are finding value in VMware acting as the common software platform to help simplify the complex move into cloud environments while allowing IT teams to take advantage of the latest networking trends. We believe VMware's products for VCPP, networking software, HCI, and EUC should provide sustainable growth.

In our view, VMware is benefiting from multiple networking industry trends. We believe that recent product announcements, including VMware Cloud on AWS being available in Germany and VMware Cloud on AWS GovCloud for the U.S. public sector, create large growth opportunities within the public clouds. Dell's ownership of VMware has created rapid vSAN software sales as enterprises embrace hyperconvergence infrastructure. The company is profiting from Dell's VxRail surpassing a $1 billion annual run rate, and VMware could be considered the standard for HCI network software.