EMC Shares Vexed by VMware

Updated from 10:53 a.m. EST

SAN FRANCISCO -- VMware's(VMW Quote - Cramer on VMW - Stock Picks) lower growth outlook for 2008 continues to lash the prospects for EMC(EMC Quote - Cramer on EMC - Stock Picks), while the macroeconomic climate lassoes both tech performers.

In its earnings report Monday, VMware predicted more moderate growth for the current year. Early Tuesday, EMC, which owns 85% of the newly public virtualization company, projected overall good expectations for its business in 2008.

But the twin fortunes of the makers of products for corporate data centers are entwined. At "only" 50% growth in 2008, VMware will still outrun projections for most tech companies.

But its lower rate -- revenue grew 88% in 2007 -- pulled the rug out from under EMC, which had already traded at a steep discount when the value of its VMware stake vs. VMware's stock price is deducted.

As VMware growth decelerates, look for EMC to consider fully spinning it off in 2009, when certain tax liabilities on the 2004 acquisition expire.

As a hedge against a downturn or a split from VMware, EMC has forged several new product lines and is entering alternative markets, such as an on-demand storage service.

IT spending will grow in 2008, "but it will be a couple points less than in 2007," EMC Chairman and CEO Joe Tucci said on a conference call Tuesday. "To date, we haven't seen much negativity happening in the market, but it's prudent on us to be cautious."

Excluding VMware earnings, EMC projected EPS, less items, of 88 cents in 2008 on revenue of $13 billion. VMware is expected to add 16 cents a share to the bottom line and nearly $2 billion to EMC's top line.

Caris analyst Shebly Seyrafi lowered his EMC price target to $21 from $30 on Tuesday, "to reflect a lower valuation for VMware." EMC is not a client of the firm.

VMware's consensus price target dropped to $86.50 Tuesday, from $100 the day before, according to Thomson Financial. EMC's remained at $25.

EMC was down $1.13, or 6.7%, to $15.78, trading at 18 times 2008 earnings, ex-VMware, and 15 times inclusive.

But VMware shares were reeling Tuesday, down $27.30, or 33%, to $55.70, to trade at 48 times 2008 earnings.

EMC's core information storage business performed well in the fourth quarter, up 14.8% year over year, to $3 billion. That business is forecast for 5% growth this year. The newer content management business grew faster, at 25%, to $238 million, and is projected to add 8% in 2008.

Technology Business Research analyst Allan Krans wrote that the information infrastructure results were more impressive for being driven almost entirely by organic growth.

EMC's Clariion storage product, targeted at the mid-market, did well, growing 15% year over year, despite slower sales through its partner channel Dell(DELL Quote - Cramer on DELL - Stock Picks) than in the third quarter.

The midrange storage business "is going to continue to be a double-digit grower for us," Tucci said. "We are a strong believer that in the mid-range and low-end [markets] the multiprotocol systems are going to dominate." EMC recently added new multiprotocol storage arrays and products with flash memory drives for these markets.

EMC's RSA information security business, a 2006 acquisition, grew an impressive 30% year over year, to $148 million. That business is projected to grow 16% in 2008.

The company's operating margin of 18.3% was flat year over year.

EMC saw its fastest growth in Latin America, up 27%, compared to 21% growth for Asia/Pacific, 23% for Europe and 16% for North America.

While signs of a slowdown at VMware for the first half of 2008 were expected, "the trend is happening sooner than we expected and much sooner than the bullish expectations" of the Street, Cowen analyst Walter Pritchard wrote Tuesday. Rather than competition or a weak economic environment, he believes the company's ability to penetrate its market at such a clip is flattening out. VMware is not a client of Cowen.

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