Opinion: EMC's cashing in on VMware IPO

VMware has Krispy Kreme appeal right now

Q: What's the deal with EMC spinning a small piece of VMware public? -- C.W. Saratoga, Calif.

A: The deal is that every time folks start to poo poo EMC, and specifically Joe Tucci, they do something that makes me shake my head with amazement.

This move is pure, unadulterated genius.

The uncontested facts of the case:

  • EMC's shareholders have been essentially sitting on stock that has had no material appreciation in many years. The company had roughly the same market valuation in 2000 when Mr. T inherited a nightmare, everyone hated their EMC rep, and the company did about $6 billion in revenues and lost a big pile of dough. Now it has doubled revenues and is making a pile, but the stock hasn't moved.

  • VMware is the darling of tech right now. They are on a $1 billion plus annual run rate, and Google is the only one with more buzz. A $1 billion revenue software company with any buzz whatsoever is trading at a valuation between 12 and 30 times revenues -- that's $12 billion minimum to you and me -- but with EMC's stock stuck in neutral, EMC stakeholders aren't realizing any of that value.

  • EMC can't use its own stock options as a way to keep executives and key employees from running away. With no appreciation, it has to pay its folks lots of cash to keep them. It's an impossible task when the market is back and the Valley is humming.

  • Joe is being pressured from every conceivable angle to drive shareholder value. If he sits still, he's a private equity target, which will rip apart the place and drive value by selling off the pieces. Stakeholders will support that play if they have been sitting on the stock long enough. Insiders know how smoking hot VMware is right now and want a way to participate. (FYI, Mr. T's pay plan is highly leveraged on stock appreciation. He is very incented and has been for some time to move the value way up.)

The play

  • EMC owns 100% of VMware, which it bought for cash at the outrageously low price of $635 million. That, as they say, was a good deal. The company will spin out 10% of VMware and sell it to the public (which is not you, by the way), retaining 90% of the ownership. Here's what will happen:

  • VMware will be priced by the underwriters at some value, EMC will want it higher, the buying community (the funds) will want it lower, the underwriter will get a huge 7% fee (normally) for effectively doing nothing, and market economics will take over and a price will be reached. That price is based on what the assumed value of VMware is as a stand-alone entity. Let's say it's $10 billion for ease of math. EMC will sell 10% of VMware to the public (funds) for $1 billion. 

  • That billion goes into EMC's bank account. That billion doesn't really change the overall EMC value (i.e., stock price) too significantly. The company already has $6 billion or so in cash and current assets, and it is valued at around $29 billion. EMC shareholders just got a billion dollars, which on paper will only add pocket change to the price of a share.

  • What will change the share price is the unrealized (and now liquid) value of VMware that EMC owns. If the VMware stock goes out at $12 (for a $12 billion value) my guess is the demand will instantly take it up to say $20 (for a $20 billion value). That means that EMC now holds 90% of $20 billion in value, which is $18 billion more -- add $18 billion to the $29 billion in value it already has and it looks like the market cap of EMC (on paper) shoots up to $47 billion or roughly 50%, which in theory takes the stock from $14 to $21. People are probably fairly pleased in that scenario.
  • It is possible that the VMware stock will not move at all.

At EMC's IPO in 1986, Dick Egan was totally pumped that his stock stayed exactly where it came out because he figured that meant he priced it perfectly and didn't leave any money on the table. That could happen here, but I doubt it.

VMware has Krispy Kreme appeal right now, and emotional buying is what moves stocks to insane heights. If that happens, and the stock moves up to a crazy $50 billion valuation (remember, this is a supply and demand game and this will be a sexy offering on buzz and growth story), then not only do the EMC shareholders get a theoretical 150% gain on their holdings, but it gives EMC a massive opportunity to cash out big. It would most likely do a secondary offering right away and sell an additional 10%-15% of its holdings to the public, except this time the price would be $50 a share, which would give the company a cool $5 billion more in cash, and still let them hold 75%-80% of the VMware stock. Yikes.

Perhaps the smartest thing this does for Mr. T is it enables him to use VMware options as a way to keep the folks he wants to keep and attract outsiders he wants to bring in. This is how the game is played, and the guy with the hot stock options (priced properly and never back-dated of course) always gets the nod from the talent pool. This is one area that has concerned me as an observer, so it must have been concerning them as well. I have no more concern, since they are about to have one of the hottest levers available.

Done right, and with some luck, this could be not only a financial boon for EMC, but more importantly, an emotional boon to get back some of that swagger and mystique that has been played down as the company has grown and become "adult," per se. Done wrong, and with bad luck, it could be that it causes "us vs. them" issues and de-focus the mainstream EMC business. I'm an optimist, sometimes, and am going to stick with the "this is freakin' brilliant" mantra until proven otherwise.

Send me your questions -- about anything, really, to sinceuasked@computerworld.com.

Steve Duplessie founded Enterprise Strategy Group Inc. in 1999 and has become one of the most recognized voices in the IT world. He is a regularly featured speaker at shows such as Storage Networking World, where he takes on what's good, bad, and more importantly, what's next. For more of Steve's insights, read his blogs.

Copyright © 2007 IDG Communications, Inc.

7 inconvenient truths about the hybrid work trend
Shop Tech Products at Amazon