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HankRearden

Michael Luddy

EMC AT A GLANCE

P/E ► 35.1 AVG EV/EBITDA ► 20.8 AVG ROA ► 4.7% AVG ROE ► 7.1% AVG Debt to Equity ► 0.726 AVG Current Ratio ► 1.96 AVG Interest Coverage Ratio ► 8.56 AVG

 

 

 

 

 

 

EMC (NYSE:EMC) has been the world leader in high end data storage solutions for the past seven years. The company sells high performance hard drives to companies that demand large, data intensive applications, including financial services, telecommunications, Internet and health care. In 2007, the company had revenues of $10.6 billion in this part of their business, representing 80% of its overall sales.

EMC has increasingly branched out beyond data storage by acquiring a range of smaller companies and is currently the seventh largest provider of enterprise software in the world. Product offerings include software encryption and security products (RSA Security, Network Intelligence), content management for internet businesses (ProActivity Software Solutions), and operating system virtualization software (VMWare) markets. While these companies represented 14% of revenue in 2006, they grew at a rate of 78% versus 2005, compared to an 8% growth rate for storage over the same time period (including newly acquired companies). Successful integration of these companies will be important to EMC’s continued expansion beyond storage.

EMC owns 87% of VMware Inc. (VMW), whose stock went public in August 2007 and rapidly increased in value in the three months after the IPO. As of October 2007, EMC's stake in VMWare alone was worth nearly $35 billion, implying that nearly 80% of EMC's value came from its ownership of VMware. In third quarter 2007, EMC sold over $115 million worth of VMWare shares to Cisco Systems (CSCO). This helped EMC achieve $493 million in profits, a 74% increase in profits over the previous quarter. EMC said it does not plan to sell anymore shares of VMWare.

The company is dependent on technology capital spending by its customers and is therefore highly sensitive to economic declines; IT spending is often one of the first items cut during a downturn. EMC has spread the risk of regional economic slowdown by expanding its geographic footprint. In 2007, 45% of revenues came from outside the U.S., and EMC has made investments in China to support a potential increase in IT demand in the region.

Customers and Products

Data Storage Solutions

Hard drives are the slowest component of modern computers; writing bits on a hard drive is much slower than streaming electrons through a processor. Exacerbating this problem is the fact that many large scale business applications need to store data in a central place. Normal hard drives just aren't fast enough for large scale, data intensive applications such as financial data, Web 2.0, audio and video, supply chain management, and medical records. Furthermore, the physical nature of hard drives makes them prone to failure and malfunctions necessitating constant upkeep and backup.

For these reasons, many businesses focus a tremendous amount of capital on high performance hard drives. Industries particularly affected include health care, telecommunications, internet retailers, electronics, and financial services. For instance, the recent Introgen Therapeutics (INGN) The core of EMC's customers are large businesses that rely on high end data storage solutions to manage e-mail, inventory, supply chain, backups and regulatory and compliance information (e.g., Home Depot (HD), Panasonic, Toyota Motor (TM), JetBlue (JBLU), ING Group (ING)). EMC also acts as a consultant for its high end storage products, providing support, services, maintenance, and help integrating these systems into the business.

Computer Virtualization Technologies

A growing part of EMC's business is computer virtualization, a technology that enables multiple operating systems to run on one physical computer. This technology has several important implications:

• It allows a computers' tasks to be abstracted from a physical machine. As a result, backup and disaster recover are much more flexible and comprehensive and data can be moved or restored to a different machine in a manner of seconds. This alleviates the need to have duplicate copies of every business critical machine, and reduces IT costs.

• Computer hardware resources are more flexible. A powerful computer can run multiple tasks concurrently across different operating systems such as Linux, UNIX, Windows and Mac at the same time.

Computer virtualization is just starting to gain widespread acceptance, and its main customers are telecoms, pharmaceuticals and technology related businesses. Because of the advanced technical details and administration overhead of virtualized computer fleets, VMWare also has strong customer lock-in and high profit margins. Fierce competition in this lucrative segment, may threaten VMWare's position as the market leader. In particular, a number of open source (mainly Linux) companies are developing virtualization technologies, and Apple (AAPL) may be developing the technology for itself, too.

EMC's subsidiary VMWare focuses on virtualization technology and produced 2007 revenues of $1.3 billion. In third quarter 2007, EMC sold over $115 million worth of VMWare shares to Cisco Systems (CSCO). Approximately 5% of EMC's operating revenue and 3.6% of revenue growth has come from VMWare over the last two years.

Other Products and Services

EMC has historically acquired other businesses to diversify its offerings. In total, these business units contributed about 7% to total revenues in 2006 (up from 5% in 2005). There is still significant uncertainty whether EMC's recent acquisitions outside of its core business lines will pay off.

Business Influences

Sensitivity to capital expenditures from other businesses

EMC makes most of its revenues from business-to-business sales, thus exposing the company to significant dependence on other businesses' capital expenditures. Expenditure on IT infrastructure is usually among the first items cut during economic declines. For this reason, EMC shows significant market sensitivity, (Beta: 2.1) than other companies. EMC rode the wave of economic expansion in '05-'06 and grew revenues at a rate of 16.2% each of the past two years. This growth continued despite an economic slowdown in early 2008, with a revenue growth of 18.6% in '07. Businesses currently have excess cash on hand and have primarily been using it for share buy backs and to change their capital structures. EMC should be positioned well if this general trend shifts toward infrastructure upgrades and expansion.

Foreign investment growth

EMC is a major international player. Foreign revenue grew from $3.6 billion in 2004 to $5.9 billion in 2007, a growth rate of 17.9% per year.

In addition to these diversified revenue streams, EMC has made a significant bet on China. It has partnered with Oracle (ORCL) to establish a technology center in China for the display and development of their products. It is the first such center outside of the United States and Europe for the two companies and implies a future emphasis on the Asia-Pacific market. EMC has also begun spending on a $500 million facility in mainland China to focus on software development research. This should allow EMC to tap the large number of highly educated engineers in China, who often command salaries significantly lower than equivalent workers in the US and Europe. EMC also reported that it will be putting another $500 million into China over the next five years. The investment is primarily for a research and development facility in Beijing.

Both of these endeavors should allow EMC to tap into the strong expected growth of IT in the region, especially if Asia-Pacific grows at a significantly faster rate than North America and Europe. EMC may be well positioned to take advantage of this Pacific boom with approximately 45% of revenues already coming from overseas.

Competition

EMC has significant competition from other IT infrastructure providers and consulting companies such as Hewlett-Packard Company (HPQ), IBM, and Unisys (UIS), Hitachi (HIT). In the past several years, these companies have introduced more comprehensive offerings and consulting services that compete with EMC's main business lines. Additionally, these competitors all offer more comprehensive computer hardware, as well as consulting and support services that make them attractive alternatives for businesses that seek broader services. In addition, lower end storage devices are producing significant speed improvements, bring pressure from the mid-range storage market.

2006 Percent market share of the $14 Billion External Storage Market

The virtualization market is less mature than hard drives but has increasing competition. While VMWare has a commanding lead in virtualization business with 55% of total market share, threats are coming from several significant directions. Microsoft (MSFT) has placed a bet to offer products that run its proprietary operating systems exclusively. On the other hand, open source providers are entering this fast-growing sector. Already XenSource, an open source provider, has developed products with support for Windows operating systems and presents a viable alternative to VMWare.

2006 Percent market share of the $900 Million Virtualization market

References