New VMware CEO Aiming High

Paul Maritz looks to carry the company into its next phase of hypergrowth.
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SAN FRANCISCO -- VMware's (VMW) - Get Report new CEO sees the company not as a mere $2 billion revenue engine but as a multi-billion-dollar software machine.

After

the ouster of co-founder Diane Greene Tuesday

, newly appointed Chief Executive Paul Maritz says he will build atop the groundwork laid by his predecessor.

Maritz describes expanding the virtualization software company's role to providing Internet-hosted computing services, also known as cloud computing, to its clients. Virtualization software enables corporate data centers to use server hardware more efficiently by allowing them to run multiple operating systems and software programs simultaneously.

By tapping bigger opportunities than it has to date, the company will give clients more flexibility "to meet their computing needs, more flexibility to use resources, both inside computer centers and outside in the cloud," he said.

Maritz became

EMC's

(EMC)

chief of cloud computing after the acquisition of his startup, Pi Corp. Before that, Maritz ran several of

Microsoft's

(MSFT) - Get Report

flagship software brands before leaving the company in 2000 after 14 years.

Microsoft, which in June added virtualization software to its Windows Server 2008, is now seen as a threat to VMware's revenue stream. "I have a deep appreciation and respect for Microsoft," Maritz said. "But there's nothing magic there. The trick is to stay ahead of the competition," which VMware has done, he added.

"The irony of all this is that the person who developed some of

Microsoft's market-dominating strategies is Paul Maritz," says Yankee Group software analyst Carl Howe. "He's the guy who's going to be on the other side of this. This was a conscious and carefully thought-out plan" on EMC's part, he adds. EMC is majority owner of VMware.

Maritz describes the change of guard at VMware as a natural transition from the founding leadership to management that takes successful young companies to the next phase. "The board felt that, at this stage of the company's growth, it needed operational leadership," Maritz says.

EMC decided it was better to take a short-term hit to VMware's stock price in favor of greater potential long-term gain, says Howe. Although EMC will be able to spin off the rest of its stake in VMware in early 2009, VMware's move Tuesday suggests that won't happen, he added.

Howe interprets EMC's move as a statement of intent to hold on to VMware, "if for no other reason than valuation."

EMC may even have wanted to see VMware's stock price fall to lower multiples before the expiry of tax implications from a full sale of its stake in 2009, Howe suggests. That stake wasn't fully represented in EMC's stock price, making EMC a potential target for a leveraged buyout and full spinoff of VMware, enabling an acquirer to get EMC on the cheap, Howe says.

Shortly after VMware went public in August 2007, its price soared to $125 and remained near $100 for several months, while EMC's stock never fully registered the value of its 85% ownership of VMware. While VMware's price catapulted beyond its offering price of $29, EMC shares only briefly broke past $25.

Howe credits former CEO Greene with anticipating competitive threats from

Citrix

(CTXS) - Get Report

, Microsoft and others by shifting its revenue base away from its basic virtualization product -- now free -- to higher-priced management tools, such as VMotion, which lets IT managers move software programs to other servers while they're in use; schedulers; and distributed power management.

"Diane had set up a lot of the pieces to mount a good defense" against Microsoft, Howe says. "But EMC just decided that Paul was the right person to have in the leadership."

Maritz says Pi Corp., which EMC acquired in February, develops software tools that are complementary to virtualization, taking advantage of virtualization's scalable infrastructure.

After VMware warned Tuesday that 2008 revenue will come in below the projected 50% growth rate, the stock ended Tuesday down $13, or 24.4%. Shares were down 76 cents, or 1.9%, to $39.43 in recent Wednesday trading.

After a spate of analyst revisions Wednesday, VMware's one-year price target fell to $61, from $67.50, according to Thomson Reuters. Lehman Brothers reduced its price target to $41 from $75 and now expects full-year EPS, excluding items, of 99 cents. Wachovia dropped its 2008 EPS estimate to 95 cents, from $1.06. The EPS consensus estimate of analysts dropped by a penny to $1.03, although many analysts have not changed estimates.

Baird analyst Jayson Noland wrote Tuesday that some of VMware's channel partners reported a license growth rate for the second quarter of 22% year over year, well below revenue guidance "and possibly diluted by the sheer number of newly added VMW resellers."

Resellers "also believe the competition is lagging VMware technically," Noland wrote. "Our reseller input on VMware was positive in a tough overall quarter." Baird makes a market in shares of VMware.

But Noland raised concern that Greene's departure would prompt defections.

Greene had positioned herself as a Chinese wall and virtual sole point of communication between EMC and the management of VMware. With her replacement by EMC's hand-picked successor, the storage company could take a greater hand in running VMware.

EMC would be smart to resist meddling too deeply in software development, or else risk an engineering brain drain.