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VMware Must Conquer the OpenStack Battleground if It Wants to Grow

NEW YORK (TheStreet) -- Virtualization and cloud giant VMware (VMW - Get Report) is not in a good place.

The company, which reports second-quarter earnings Tuesday, is up 4.5% for the year to date and trades around $94. But this is a "nervous" 4.5%. There has been no real conviction to the stock's direction. Since the stock reached its 52-week high of $112.82 on April 2, VMware has lost more than 15% of its value.

Although VMware is the undisputed market leader in virtualization software and cloud-based infrastructure, the company is now facing credible threats from Citrix (CTXS) and Red Hat (RHT), among others.

Investors want to know to what extent VMware can grow in the new battleground that is OpenStack  while also advancing its server and system administration business. This is the only way from VMware to grow into its valuation and justify that it deserves investors' confidence to bless it with a P/E that doubles the industry average.

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The stock, which trades at a P/E of close to 40, is not cheap. Aside from almost doubling the industry average P/E of 22, VMware shares don't offer better value from, say, Microsoft (MSFT), which competes in the same markets. Not only does Microsoft pay a dividend, Microsoft comes with significantly less risk.

It's true VMware is growing faster than Microsoft and, for that matter IBM (IBM). However, investors must consider the expected earnings from VMware's growth may never materialize, because VMware's market is rapidly changing.

What we've come to know as "the Cloud" is shifting in a new direction. OpenStack is the new battleground and it's not going away. Several companies have already proclaimed themselves experts. This is even though they have yet produced the numbers to prove it.

Jim Whitehurst, Red Hat's CEO, told me recently that "no one knows OpenStack better than us." Red Hat has a long history with open source and 90% of Fortune 500 companies are already using Red Hat's software.

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