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VMware Shares Dogged by Dell Storage Strategy

The stock continues to pull back, but a duel looks doubtful.
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SAN FRANCISCO -- Given the coverage earlier this week of Dell's (DELL) - Get Dell Technologies Inc. Class C Report acquisition of privately held EqualLogic, investors can be forgiven for getting the erroneous impression that the deal poses problems for virtualization software darling VMware (VMW) - Get VMware, Inc. Report.

Following Dell's announcement, shares in recent-IPO hotshot VMware dropped 4% on Monday, hitting a level they hadn't seen since numerous

target-price revisions moved the stock upward of $120 on Oct. 29.

On Wednesday, shares had fallen more than 4% to $106.21, marking a drop of about 12% since Oct. 29. While some pullback could possibly have been foreseen in an issue that doubled in its first two months of trading, the Dell news seems to have halted VMware's momentum like nothing else.

Several reports have been lumping EqualLogic into the "virtualization company" category and comparing it side by side to VMware.

But as a maker of storage systems, EqualLogic doesn't compete with VMWare. In fact, the two work together.

"EqualLogic is hardware," says Parag Patel, VMware's vice president of software and storage alliances. "VMware infrastructure software interacts with EqualLogic's network storage."

Moreover, VMware is vendor-neutral, optimized for storage equipment and protocols from numerous hardware vendors.

The comparisons get even hazier when a software developer is touting its virtualization capabilities.

Virtualization software enables companies to run multiple operating systems on a single server, helping businesses make more efficient use of equipment and reduce energy consumption. Server use is currently estimated at 15%, but virtualization software typically raises that to 60% or better.

When investors try to size up the VMware growth story, marketing jargon blurs the distinctions between VMware and other companies that are trying to work the V-word into their news. This seems to feed fears of competitive threats that could force pricing pressure on VMware, which is viewed and priced as the Mercedes of virtualization.

Citrix Systems'

(CTXS) - Get Citrix Systems Inc. Report

XenSource virtualization software is more comparable to a Mini Cooper: a stripped-down, lower-priced competitor that's going to be outpaced on the Autobahn and probably won't impress the CEO when he goes for a test drive. Citrix is virtually the only company with the most basic software crucial to get virtualization started -- the hypervisor.

But XenSource doesn't have the market-share heft to threaten VMware. It hopes to change that with price.

Citrix's low-end software is less costly than VMware's full enterprise software, VMware CEO Diane Greene said Wednesday at the Goldman Sachs Software Retreat. "But that's not an apples-to-apples comparison."

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Customers want full enterprise software, regardless of the price, Greene added. "It's about ROI

return on investment, not upfront costs."

VMware's revenue

grew 90% year over year during the most recent quarter, and the company is expected to take in more than $1 billion this year.

The bigger threat to VMware may come from


(MSFT) - Get Microsoft Corporation Report

, which won't release its hypervisor Viridian until the second half of 2008. The virtualization software will be added to the next upgrade of Windows Server. But it will be within the Windows operating system, as opposed to being installed on naked hardware without an operating system as VMware's hypervisor can be. Operating systems add cost and complexity to a box.

But VMware is a threat to Microsoft, too. And the Redmond, Wash., software giant is wary about the field of virtualization.

The technology throws the revenue model for all traditional software vendors into question, according to Greene. For developers, the issue is how to charge for multiple uses of their software on the same physical machine and virtual machines. Companies like Microsoft are working on it, Greene said, "but they are moving very carefully because it can have huge repercussions on their revenue."

Customers are realizing the ability to virtualize on a single machine is "just a tiny piece of what virtualization can do for you," Greene said. To achieve real reductions in capex and op-ex, companies need virtualization infrastructure: all the management bells and whistles controlling a data center full of servers, she said.

VMware is still adding to that infrastructure software, making virtualization management more "plug and play."

VMware's hardware partners, such as


(HPQ) - Get HP Inc. Report

and Dell, plan to sell servers with embedded VMware hypervisors. "And most servers do not come with an operating system installed on them," Greene said.

"We work with

Microsoft because we're the best way to deliver Microsoft applications and run Windows today," Greene said. But the Microsoft approach installing virtualization on top of Windows will not be a long-term solution, she predicted. Start-ups are moving toward developing virtual appliances -- software programs that come with their own mini operating systems.

Its those developments, not Dell's purchase of a hardware maker, that should ultimately determine VMware's market-leading stamina.