Big Blue Lifts Hopes for VMW and EMC

IBM's solid earnings could bode well for VMW and EMC.
By Ivy Lessner ,

SAN FRANCISCO -- IBM's (IBM) - Get Reportsolid earnings report Wednesday has raised expectations that other data-center tech suppliers won't disappoint when they report first-quarter earnings this week.

IBM raised guidance after a quarter during which U.S. as well as international tech spending grew, lifting Big Blue's revenue 11% year over year.

That reassured investors nervously awaiting a spate of earnings reports this week. But the jury's still out, especially at the leading virtualization-software company.

VMware

(VMW) - Get Report

will post first-quarter earnings after the close of the market Tuesday.

EMC's

(EMC)

earnings report follows on Wednesday morning.

EMC is a majority owner of VMware, which went public Aug. 13.

Analysts expect VMware to report EPS, excluding special items, of 22 cents on revenue of $422 million, according to Thomson Financial. EMC is projected to earn 16 cents a share, less items, on a top line of $3.45 billion.

Atlantic Trust Private Wealth Management analyst Chuck Jones, who holds EMC in his own account, says the storage-hardware company's business lines are highly correlated to IBM's product lines. "They both sell to enterprise customers. IBM's storage business did fairly well."

"From what I've picked up from contacts, business-to-business selling is going just fine right now," Jones said. "I'm not expecting gangbusters

from EMC, but it should be a pretty decent quarter." EMC is not a core holding of Atlantic Trust. Jones and Atlantic Trust have never bought VMware.

"We believe that VMware made Street estimates for the March quarter," BMO Capital Markets analyst Keith Bachman wrote in a note Monday. VMware is not a client of the firm, and BMO does not make a market in its shares.

At VMW, which has a reputation for being high-priced, the top line may have come under pressure as the company's selling partners tried to close deals in a difficult business environment.

While VMware's direct-sales pricing did not appear to change during the quarter, Bachman noted, distributors indicated they had discounted pricing to small and medium-sized businesses by 20% to 25%. Bachman predicted that VMware will continue this trend as the year progresses, "limiting revenue upside."

Bachman wrote that VMware likely will get more aggressive in pricing to thwart competitors entering the market, including

Citrix

(CTXS) - Get Report

, Virtual Iron and eventually

Microsoft

(MSFT) - Get Report

.

Those trends were also reported Monday by UBS analyst Heather Bellini, who found that customer adoption at VMware slowed, with several resellers noting delays in contract signings due to the macro environment. "Some partners also saw VMware get aggressive with pricing to get deals done and to drive market share," Bellini wrote. VMware is an investment banking client of the firm.

But Raymond James analyst Michael Turits wrote in a note Monday that most resellers reported meeting or exceeding their sales quotas, indicating strong demand. "Longer term, we believe VMware faces revenue, pricing, and margin risk with increased competition from Citrix, Microsoft and others." Raymond James makes a market in shares of Citrix.

Since VMware forecast slower earnings growth at its last earnings announcement than it experienced in 2007, the price of VMware has fallen 32%, closing Monday at $56.07. EMC is down 6% over the same period, closing at $15.89.

Assuming VMware is worth $50, its value within EMC's share price is $8, Caris analyst Shebly Seyrafi wrote in a note Monday. With EMC trading at $15, core EMC (excluding VMware) trades for $7, or roughly 11 times 2009 earnings. "This is a very low multiple for EMC considering we believe that core EMC should be able to grow revenue at around 9% a year," Seyrafi stated.

EMC is fairly valued without its stake in VMware, Jones said. "It's undervalued when you take into account VMware's equity value."

EMC is precluded from selling its stake until 2009 due to tax repercussions. Without the ability to unlock the value of that stake, "it's hard to say you have to own EMC right now," he added.

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