The Real Problem with VMware and Virtualization (VMW, EMC, CTXS, RHT)

Hand plugging ethernet cable into wall socket
Hand plugging ethernet cable into wall socket

VMware Inc. (NYSE: VMW) is getting to spend its turn inside the barrel after earnings. The report itself was not so bad, but guidance and the implications allowed Wall St. brokerage firms to run for cover. It is not often that you see a 19% drop in VMware due to its dominance in virtualization, but that is what we are seeing.

Things are soft enough that VMware also got into the pink slip charades by announcing that 900 jobs, or almost 7% of its force, will be eliminated. For the quarter, the virtualization software maker posted adjusted diluted earnings per share (EPS) of $0.81 on revenues of $1.29 billion. In the same period a year ago, the company reported EPS of $0.62 on revenues of $1.06 billion, and the Thomson Reuters consensus was $0.78 EPS and $1.28 billion in revenues. VMware's outlook shows that it now expects revenue in a range of $1.17 billion to $1.19 billion for the first quarter, and it expects to post revenues of $5.23 billion to $5.35 billion for the year, south of the $1.25 billion consensus for the quarter and under the $5.42 billion consensus for the year.

VMware expects full-year license revenue to rise by 8% to 11% in 2013, a lower annual growth rate than the 13% increase in licensing revenue in 2012. The long and short of the matter is that it seems the available future market share for virtualization is becoming smaller and smaller. It is not that virtualization is waning, but finding the number of companies and new systems that need virtualization is getting harder as all the big companies have made their moves already in virtualization.

We have read repeatedly how ever more businesses have made the move to virtualize their systems, and it is shocking how Wall St. got this one so wrong. Here are the multitudes of analyst downgrades we have seen on VMware so far on Tuesday:

  • Cut to Equal Weight at Morgan Stanley

  • Cut to Neutral at Piper Jaffray

  • Cut to Neutral at Stern Agee

  • Cut to Hold at Topeka Capital

  • Cut to Neutral at MKM Partners

VMware shares are down 19.6% at $78.90, and that will be a new 52-week low as the 52-week trading range had been $79.46 to $118.79. The move is also hurting EMC Corp. (NYSE: EMC) as the superdominant shareholder. EMC shares are down 6.6% at $23.53. Citrix Systems Inc. (NASDAQ: CTXS) is down 4.25% at $68.41 and Red Hat Inc. (NYSE: RHT) is down by 2% to $55.07 so far on the news.

Even after the large drop this morning, VMware still trades at almost 6.5-times expected revenue and trades at almost 25-times expected earnings. What happens when growth has peaked in high-beta stock sectors? Usually you see a share price adjustment and earnings and sales multiples come down closer to the rest of the market.

Filed under: 24/7 Wall St. Wire, Software, Technology, Technology Companies Tagged: CTXS, EMC, RHT, VMW