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Analysts Say Sell VMware, Time To Buy?

By Ben McClure

Tickers in this Article: EMC, CTXS, MSFT, VMW

Finally, we might be seeing the start of a bottoming-out in VMware (Nasdaq:VMW) stock. What's the first clue? A sell-side analyst at UBS AG (NYSE:UBS) now rates the virtualization software vendor a sell.

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The former market darling's value has plunged to $19.00 from a high of $122 reached in November last year. All the while Wall Street analysts stayed fairly bullish on the stock. The new downward shift in analyst sentiment, paradoxically, could signal an entry point for savvy investors looking to get a piece the fast-growth software company.

Room to Grow in the Global Market
Indeed, the signs are encouraging. VMware continues to hold the lead in the virtualization market, with more than 78% share of its key computer server market. Admittedly, its market share is bound to drop as players like Microsoft (Nasdaq:MSFT) and Citrix Systems (Nasdaq:CTXS) move in, but VMware still has only a tiny share of the overall global market for virtualization software, leaving it heaps of room to grow. Adoption of virtualization solutions that let companies cut IT costs is still early and at a tipping point. The software is particularly attractive in downturns, where cutbacks in IT departments are commonplace. (For related reading, see 7 Lessons To Learn From A Market Downturn.)

The shares look reasonably valued. The big correction in the share price from its highs has been painful for investors, to say the least, but the stock has cast off the far-fetched multiples that kept its valuation so high.

According to estimates by IDC, a leading provider of global market insights specifically regarding information technology and telecommunications, virtualized servers could jump to about 60% of the total by 2011. As such, it will be a spending priority for IT departments in 2009 despite the uncertain economic environment. Based on this, it's not unreasonable to assume that VMware can grow at 25% or more per year. Based on expected 2009 earnings per share of $1.13, VMware's price-to-earnings multiple is just over 17 times. What's more, its P/E-to-growth ratio is only about 0.65. Trading at this level, the stock is practically a give-away. (Learn to work quickly with ratios with the Financial Ratio Tutorial.)

Balance Sheet and Cash Flows
Unlike many other hi-tech shops, VMware has a solid balance sheet, with about $1.24 billion, net of $450 million in debt notes due to 10% owner EMC (NYSE:EMC). The company's net cash balance equates to $4.34 per share, suggesting that VMware has sufficient capital to fund future growth.

Meanwhile, the company continues to produce plenty of cash flow from operations. In the most recent quarter, VMware posted cash flow from operations of $244 million. That's up 23% from the same period last year and up 62% from the previous quarter. Operating margins are holding strong at about 25%.

Managing the Future
The company appears to be recovering nicely after the departure of CEO and co-founder Diane Greene. Her departure had an unsettling effect on the company and the stock back in the summer. CEO Paul Maritz, a former high-ranking Microsoft executive, seems to be quickly getting things back on track.

VMware has gone from darling to dog on Wall Street. That, in an ironic twist, makes it look awfully tempting these days. Of course, it will probably take a few more sell-side analyst sell ratings before the stock finds a floor, but the way I see it indicators are certainly compelling

For added insight, check out Turnaround Stocks: U-Turn To High Returns.

By Ben McClure

Ben McClure is director of McClure & Co., an independent research consultancy. Before founding McClure & Co., Ben was a highly-rated European equities analyst at London-based Old Mutual Securities. He also spent several years as a business/technology journalist at the Economist Group. McClure graduated from the University of Alberta School of Business with an MBA.

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