EMC Is Under Pressure to Sell VMware but Would Shareholders Win?

NEW YORK (TheStreet) -- Enterprise storage giant EMC (EMC) is in a battle to keep its 80% stake in software virtualization company VMware (VMW) .

According to a Thursday New York Post report, which cites sources familiar with the matter, EMC agreed to sell or spin off its stake in VMWare due to pressure from activist investor Paul Singer of Elliot Management Corp. That report was refuted Friday by Reuters, which cited its own unnamed source.

What should investors make of this? Keep in mind that with EMC shares rising less than 10% over the past two years, which is well below the 40% gain of the S&P 500, management will continue to feel pressure to do something and unlock value for shareholders. Shares are at $29.65, up nearly 18% for the year to date. 

VMware, which competes with Red Hat (RHT) and Microsoft (MSFT) , among others, specializes in software that allows users to operate in virtualized machine environments. VMware's technology helps corporations reduce costs and operate more efficiently, whether via data storage management or in the cloud.

Breaking off from VMware is something EMC has long resisted. EMC has maintained that keeping both companies together presents an added advantage that helps win business over the likes of Hewlett-Packard (HPQ) and NetApp (NTAP) .

It is, however, for this exact reason that Elliot Management believes VMware will be better off on its own. Elliot Management, which owns a 2% stake in EMC, argues that spinning off VMware would "boost the value of both companies."

What's more, Elliot doesn't believe EMC's ownership structure of VMware suits EMC's long-term interest and believes VMware is better off on its own and for EMC to return more cash to shareholders.

Joseph Tucci, chief executive of EMC, calls VMware one of its "most strategic assets."

After buying VMware 10 years ago for $600 million, EMC doesn't want to let go of its golden goose. Nevertheless, VMware, which has a market cap of roughly $41 billion, would have plenty of suitors if it were to get spun off from enterprise companies that are looking for any advantage they can get, especially in the cloud.

VMware, which accounts for roughly 22% of EMC's revenue in 2013, has been a dominant force in helping EMC remain competitive in an ever-changing world of not just the cloud but also flash and software-defined storage. VMware is the main reason EMC continues to grow share against NetApp and IBM.

To that end, EMC risks losing VMware in a bidding war if it were to spin off its stake. An offer of $52 billion to $55 billion (enterprise value), which is 30% above VMware's current value, will get the deal done. This still may not be enough to entice EMC to sell.

With only moderate improvements expected in enterprise IT spending in 2015, EMC may disappoint investors for while longer -- even with VMware. So despite being the clear-cut leader in the storage business, EMC still needs a thriving environment.

In the meantime, Elliot Management is hoping someone steps up and presents EMC with an offer for VMware that it can't refuse.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.


TheStreet Ratings team rates EMC CORP/MA as a Buy with a ratings score of A. TheStreet Ratings Team has this to say about their recommendation:

"We rate EMC CORP/MA (EMC) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, expanding profit margins, good cash flow from operations and increase in stock price during the past year. We feel these strengths outweigh the fact that the company has had sub par growth in net income." You can view the full analysis from the report here: EMC Ratings Report

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