VMware Inc. (NYSE:VWM) sells software integral to the operation of websites and other network computing resources. VMware's virtualization software can make multiple physical computers behave like a single, ultra-powerful "virtual" machine, or split apart a single physical machine and make it behave like multiple computers (for example, to host several different websites on the same server). With virtualization software, websites can be run more cheaply and reliably by allowing webmasters to deploy resources "virtually" on an as-needed basis, rather than forcing them to keep excess capacity up and running to handle occasional traffic spikes and crises. In addition to software sales, thirty percent of VMware's revenue comes from services such as maintenance and upgrades and training. These revenues are recurring and create steady, ongoing cash flows.
In 2006, VMware saw an explosive 82% increase in sales over 2005 figures, reflecting virtualization's rising popularity in the marketplace. Virtualization, in its current form, is a young market; in 2006, only about 2% of physical servers ran virtualization software, and about 8% of logical servers, which aren't limited to one physical location, were virtualized. Right now, one of the main barriers to the penetration of virtualization technology is the perceived complexity of implementing a virtualized system. As IT professionals become more familiar with virtualization, the technology should take off. By the year 2010, it's estimated that around 15% of all physical servers will be virtualized, as opposed to 2% in 2006.
VMware is currently the leader in the virtualization market, with its estimated market share ranging from 55% to 80%. One significant risk to VMware's long-term success is the impending competition from Microsoft. Though the software giant hasn't released much in the way of virtualization software yet, it's expected to include a free version of its proprietary virtualization software with its Microsoft Server 2008, which should hit the market in mid-2008. Though this software is expected to be pretty basic compared to VMware's fine-tuned virtualization programs, the fact that it's free and carries the Microsoft name makes it a notable competitor.
VMware Inc. provides products and services for virtualization, a technology that separates a computer's software from its hardware in order to improve efficiency. Virtualization lets customers run multiple applications from one computer or server, which can reduce spending on additional, unnecessary capacity. Though the penetration of virtualization technology is still low, it should increase dramatically as IT professionals become more familiar with the concept. As of December 2006, VMware's software had already been installed on 24.6 million x86 servers and 489.7 million business client PCs for customers across various industries (including all of the Fortune 100 and 840 of the Fortune 1,000).
The majority of VMware's sales are made indirectly through a system of more than 4,000 partners, including software distributors and resellers, hardware vendors who bundle the software with their products, and IT management services. VMware also regularly collaborates with tech giants Intel (INTC) and Cisco Systems (CSCO) to develop virtualization software optimized for use with these companies' hardware. These relationships are quite close; both Intel and Cisco hold VMware stock and a seat on its Board of Directors. By leveraging Intel's and Cisco's reputations in the computer hardware industry and VMware's leading position in virtualization software, the companies hope to develop a complete package of virtualization technology that addresses all of their customers' needs.
VMware has grown substantially over the past few years, reflecting the growing demand for virtualization products and services. The company's total revenues were up 82% in 2006 from 2005, and software license revenues increased 71% in 2006.
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VMware generates most of its revenue by licensing its software to customers. VMware's licenses are usually sold on a perpetual basis (customers pay a one-time, non-recurring fee for the right to use the product) and are priced based on the number of physical computers that will be using the software. VMware used to provide software updates free-of-charge until early 2004. The company then began charging customers for individual updates, providing an extra source of revenue. VMware still uses this model today, meaning that each copy of software licensed has the potential to continue bringing in revenue long after the initial sale.
VMware also provides several types of services, including software maintenance and various professional services. Typically, the company's service contracts last from one to five years; revenue from multi-year contracts is reported in equal annual amounts over the course of the contract. For example, a $10, 2-year service contract would count as $5 in revenue for two years in a row. These service plans offer various levels of product support, ranging from basic coverage to exhaustive technical support. Maintenance contracts also give customers the right to receive future product upgrades at no additional charge.
VMware also provides professional services for the design and implementation of virtualization technology, as well as training for end users. Both types of services, maintenance and professional, have been increasingly important to VMware's bottom line over the past few years. From 2004 to 2006, the Services segment grew to account for 30% of revenues, up from around 18%. Services usually provide higher profit margins than licensing, which should help boost the company's performance if this trend continues.
VMware serves companies in a variety of industries. Basically any company that operates its own servers or network infrastructure can benefit from virtualization services. The benefits of increased efficiency, lower IT management costs, and maximum hardware utilization, make virtualization a particularly viable option for large companies that maintain equally large networks. Some of VMware's largest customers are firms in the telecommunications, pharmaceutical, and technology-related industries; as these industries become more competitive, VMware could stand to benefit. According to some research, a typical x86 server (the standard for business networks) utilizes only 10% to 15% of its capacity; companies often run only one application per server to minimize the risk that a problem with one application will affect numerous others. While this is perhaps the safest method to ensure that one faulty program doesn't bring the whole system down, it is also rather expensive. Using VMware's virtualization technology, companies can run more than one application per server without having to worry. By allowing them to more effectively utilize their existing capacity, virtualization can cut both hardware and IT management costs substantially. Firms in competitive industries are likely to seek every cost savings they can find, which could be a boon to VMware's bottom line.
Currently, VMware dominates the virtualization market, which is estimated to be worth near $1 billion. The next leading player, however, is Microsoft (MSFT). Microsoft's offerings in the virtualization market are currently limited to entry-level products that compete with only a small portion of VMware's total product line. It has, however, announced its intention to launch enterprise-class products in the future, which would put it in more direct competition with VMware for sales. While the virtualization industry is relatively young, with plenty of room for more than one company to expand significantly, going up against Microsoft can be a daunting prospect. Even though Microsoft only competes with a few of VMware's products at present, it has already started paving the way for its future plunge into the virtualization industry. Microsoft recently implemented agreements with a number of server and software vendors to distribute certain operating systems, which just happen to disallow the use of any non-Microsoft virtualization format. If Microsoft decides to make a big push into this industry, VMware could see its market share, and sales, fall considerably.
In 2006, VMware made about 44% of its revenue from customers outside the U.S. As such, it receives payment in a wide range of currencies; its revenue, however, is reported in U.S. dollars. Any change in the exchange rates between the dollar and other currencies in which VMware conducts business could have a significant effect on reported revenues. If the value of the dollar declines against other currencies, VMware's revenues would be boosted, as every unit of foreign currency would translate to a larger number of U.S. dollars. The same applies in reverse, however; a rise in the value of the dollar would make international sales look relatively smaller. Recently, the dollar has been pretty weak in comparison to other major currencies; a continuation of this trend would be beneficial for VMware and other companies that do business outside of the country.
Currently, VMware leads the server virtualization industry by a substantial margin. The next largest competitor is Microsoft (MSFT), which looks poised to make a strong push into the market over the next year or two. Apple (AAPL) will soon release its own form of virtualization software called Boot Camp (which allows Intel-based Macs to run Windows operating systems in addition to OS X), though this is aimed primarily at consumers. Other, smaller competitors include Novell (NOVL), XenSource, and Red Hat (RHT), though none of these companies holds more than a 2-3% share of the virtualization market. The still-growing market has plenty of growth potential for all, however; there are so many untapped customer bases that it'll be a while before the firms really start fighting over business.
One distinguishing characteristic of VMware is that it's dedicated to the virtualization industry, whereas all of its major competitors have extensive operations in other areas of the technology industry. This puts VMware in a relatively more leveraged position; if virtualization takes off, it stands to benefit more than say, Microsoft, whose bottom line would look about the same either way. On the other hand, if virtualization were to fail for some reason, VMware wouldn't really have any revenue sources.