VMware Says 'Uncertainty' Will Lead to Slower Growth

BOSTON (TheStreet Ratings) -- Virtualization giant VMware (VMW) reported better-than-expected revenue and earnings for the third quarter, a sign that, despite cutbacks in corporate spending, the company is still performing at an exceptional level.

While third-quarter numbers look good, management warned that 2012 will be more of a challenge, as "growing macro uncertainty" will lead to slower growth.

Some of the highlights from Q3:

1. Revenue of $942 million, which were at the top end of guidance offered from management (range was $915 million to $940 million), and slightly above the consensus from analysts of $929 million.

2. Revenue growth of 32% over Q3 2010.

3. Non-GAAP EPS of $0.53, above the consensus of $0.49.

4. License revenue of $444 million, which was what analysts were looking for, meaning that service revenue of $498 was above expectations.

5. Management calling for fourth-quarter revenue of between $1.03 billion and $1.06 billion, in line with previous guidance.

6. Management noted that 2012 will represent a year of "challenging comparables" with first-quarter revenue expected to grow only between 18% to 22% over 2011.

7. Believe it or not, VMware is showing European growth, driven by strong demand in Germany.

8. Strong demand in Asia-Pacific region, mostly from Australia, China and India.

VMware is now trading down slightly (minus 3%) in extended trading. While at first glance it looks like a solid quarter, the stock has been priced for perfection, currently trading at 36 times 2012 EPS estimates of $2.47.

With many players now offering free virtualization alternatives (Microsoft, Red Hat), it will be increasingly harder for VMware to maintain the 30% to 35% growth totals seen over the past several quarters. Many are predicting that VMware's growth could slow to 20% over the next few years.

Despite the competitive pressures, VMware is still the dominant force in the virtualization market. Many are still willing to pay a premium for the VMware suite of virtualization services, and any uptick in business or government spending could lead to upside potential for the stock.

The company is certainly well-positioned in a market segment with the potential for significant growth. As corporations look to cut IT costs and update infrastructure, VMware will continue to benefit. At current levels, the stock looks a bit pricey, but I would look for any pullback to start a position.

Equity research manager Chris Stuart, CFA, joined TheStreet Ratings after working as a senior investment analyst with Merrill Lynch covering small-cap equity and alternative investment strategies. Prior to that, Stuart worked for One Beacon Insurance as an actuarial analyst and at H&R Block as a financial adviser.

Stuart earned his bachelor's degree in finance from the University of Massachusetts, Amherst. He holds a Chartered Financial Analyst (CFA) designation and is a member of the Boston Security Analysts Society (BSAS) and the CFA Institute.