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EMC Corp – It Will Find its Way Back…

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By: Larry Darrell
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The EMC Corporation (EMC), incorporated in Massachusetts in 1979, is a worldwide leader in disk storage systems with a 23.7% share of the market. It competes with the Hewlett-Packard Company (HPQ) and the International Business Machines Corporation (IBM) in the computer storage industry, which have a market share of 17% and 12.9%, respectively. The company has also ventured into virtualization technologies by taking an 80% stake in VMware

EMC now offers a product and services portfolio that includes data storage, information security, virtualization, analytics, cloud computing and others. The company serves both Fortune500 organizations and various smaller businesses across different industries, and generates almost half of its sales from regions outside the US.  

As of the second quarter of fiscal ’13 (2QFY13), the company reported its operations by three segments: EMC Information Infrastructure, Pivotal, and VMware Virtual Infrastructure. The current division of segments allows these businesses to focus solely on their individual product offerings, and the ways in which they can deliver and market these products, and work towards aiding customers in leveraging cloud computing and big data to their benefit.

EMC Information Infrastructure

The Information Infrastructure segment offers solutions for companies’ storage needs, and allows clients to store, manage, analyze, and protect their data using EMC’s technology. It helps increase client companies’ business agility and eliminates the cost of ownership of traditional or virtual datacenters and cloud infrastructure.

EMC Information Infrastructure is subdivided into the Information Storage, Information Intelligence, and RSA Information Security segments.

The Information Storage segment offers software, enterprise storage systems and backup products which help organizations maintain their workload. In 2012, the company also started supporting hybrid cloud infrastructures. The company’s products from this segment include VMAX, VNX, Isilon, and Atmos.

The company offers security, risk and compliance solutions to organizations under the RSA Information Security segment. These solutions allow clients to protect the integrity, confidentiality and availability of digital information over the lifecycle of the data stored.

The Information Intelligence segment aids organizations in transforming their businesses through software and cloud-based solutions and services. Through this segment, the company facilitates the transition of the post-PC era user to mobile devices by providing a smooth user experience and a swift shift to the cloud.

VMware Virtual and Cloud Infrastructure

VMware (VMW) has been at the forefront of virtualization technologies, which have transformed the ways IT services are delivered, used and built. Virtualization is concerned with the creation of virtual systems that replicate a physical resource like a server, storage device or network. The technology allows companies to improve their efficiency, agility and manageability.

VMware was acquired by EMC in 2004, and it now operates as a controlled subsidiary. EMC owns 79.7% of VMware's common shares, and has 97.2% of the combined voting power in the company.

Pivotal

VMware and EMC launched Pivotal in early 2013. The business is focused on offering platform-as-a-service (PaaS) cloud services that are focused on data analysis.

The project was provided an initial investment of $105 million by General Electric, which plans on using Pivotal’s technologies with its own data analysis tools.

The one-and-a-half-year-old business is still in its infancy stage, contributing a mere 1.2% to EMC’s consolidated revenues.

Other Investments

Founded in 2009, VCE Company LLC is a joint venture between EMC and Cisco Systems, Inc. (CSCO). VCE sells preconfigured and pretested cloud computing systems called Vblocks. The infrastructure combines computing, networking, storage, security, virtualization and cloud technologies. EMC owns 58% of VCE’s outstanding shares.

VMware and Intel (INTC) also have stakes in the venture.

Revenue Segmentation 

The company earns more than 70% of its revenues from the Information Storage subdivision (classified in its Information Infrastructure segment), which offers enterprise storage systems and software.

Products generate 60% of the Information Storage subdivision’s revenues, while the remaining come from services.

EMC earns 53% of its revenues in the US; the Asia-Pacific region contributes 13.9%; the Europe, Middle East and Africa region contributes 27.2%; while Latin America, Mexico and Canada combined account for 5.9% of its revenues.

Industry

The IT industry is transitioning to cloud computing, which is one of the most disruptive technologies to have come to the fore in recent times. For starters, cloud computing will transform IT departments across industries and force them to revamp existing infrastructure. It will allow companies to operate using various tools accessed remotely via the web – eliminating the need to buy expensive bundled software packages that have to be installed on individual PCs and laptops.

On the infrastructural front, cloud computing will eliminate the need to maintain infrastructure on the end of individual companies, since cloud services providers – EMC in our case – will do that for several companies at the same time on their end. This will free up companies’ IT resources, which can be used to improve operational efficiency and core offerings.

Another emergent theme in the industry is how the large volumes of complex data generated by rapidly proliferating mobile devices will be utilized. New, powerful cloud infrastructure provides the technology which organizations can use to mine through massive quantities of ‘big data’, and enables them to use their findings to identify new business opportunities while improving their operational efficiencies.

According to the International Data Corporation (IDC), revenues from big data storage systems will grow at a compound annual rate of 27% over 2013-17, making big data storage a $4.4 billion market by the end of that period.

However, the computer storage industry, in which EMC is a global leader, has been experiencing a decline. According to the IDC, total disk storage systems, including both internal and external, declined 5.6% year-over-year (YoY) in the third quarter of 2013 (3Q13). Nonetheless, EMC’s share in the market increased from 22.6% in 3Q12 to 23.7% in 3Q13. The company has secured a leading position in the Storage Area Network (SAN) market and the Network Attached Storage (NAS) market.

According to a research director at IDC: "Despite the revenue contraction in the third quarter, we see strong demand for offerings targeted at heavily virtualized environments, such as integrated infrastructure [...] However, this demand has been offset by several factors: reduced spending from the U.S. government, increased use of storage efficiency technologies, increased investment in public cloud capacity, and general price pressures associated with increased competitive environments."

Information Infrastructure

In EMC’s Information Infrastructure segment, the Information Storage and RSA Security subdivisions have posted year-over-year growth, but the Information Intelligence segment has declined. Information Storage contributes around 70% of EMC’s total revenues.

Information Storage products include high-end and mid-tier storage systems. In 3QFY13, sales of high-end systems declined 8% YoY to $803 million. The decline was attributable to a 40% decline in revenues from services and products provided to the US government. However, the decline was offset by growth in the sale of mid-tier systems.

The Information Intelligence group posted lower revenues year-over-year in 2013 following a slowdown in demand from consumers, who have been constrained by tighter budgets. However, with new cloud offerings in the pipeline, the company expects growth in this segment going forward.

The company’s gross margins in the Information Storage segment declined after the US government cut its spending on EMC’s high-end storage products. The segment’s margins fell to 55.7% in 3QFY13 from 56.9% in the comparable year-ago quarter.

The RSA Security segment’s margins expanded to 67.6% in 3QFY13 from 64.2% in 3QFY12, boosted by sales of higher margin products and services.

The Information Intelligence segment’s margins contracted to 63.3% in 3QFY13 from 68.1% in 3QFY12, driven by a decline in revenues from licensed products.

VMware Virtual and Cloud Infrastructure

Revenues from the VMware segment grew in the first three quarters of FY13 following higher demand for products like vCloud and vSphere. The segment is expected to continue growing as demand for software-defined data centers and hybrid cloud services rises in the future.

Stock Price Performance

The company's stock price is up 6% over the last twelve months, while Cisco is up 8% and IBM was down 3%. In comparison, one of EMC’s direct competitors, NetApp, Inc. (NTAP), has surged 25% over the period.

Over the period, EMC has also underperformed the Technology Select Sector SPDR Fund (XLK), which tracks the technology sector’s performance. The ETF is up 20% over the last 12 months. EMC has a 1.54% weighting in the ETF.

Latest Quarter Results

EMC’s earnings in 3QFY13 missed analysts’ expectations. The company recorded revenues of $5.54 billion and earnings per share of $0.40 for the quarter, which were both below consensus estimates of revenues of $5.8 billion and per share earnings of $0.45. The company reported revenues of $3.77 billion from its Information Storage segment (which generates more than 70% of EMC’s revenues), which missed consensus estimates of $4.03 billion by a wide margin.

The company’s weakening topline, blamed on the government’s spending cuts, forced the management to revise its yearly guidance. According to estimates, sales to the government account for 10-15% of EMC’s total revenues. The company also suffered because of declining demand in emerging markets.

Conclusion

But EMC, regardless of its mediocre performance during the year, is well-positioned in the fast-growing cloud computing and big data industries. The company has been acquiring companies that complement and expand its current offerings: for example, it has ventured into virtualization technologies by taking an 80% stake in VMware. The strategy will allow it to diversify its product offerings while operating as one entity, which we feel is the best strategy for a tech company going forward.

EMC has a three-year (historic) revenue and EPS CAGR of 15.7% and 32.4%. Over 2014-15, analysts expect revenue and EPS growth to be 9% and 14% YoY.

The stock is currently trading at a forward price-to-earnings multiple of 12.4x, which is a 4% discount to its competitors’ average of 12.9x. According to Bloomberg’s data, of 45 analysts who cover the stock, 38 recommend it as a buy and 7 recommend it as a hold. The stock is certainly valued cheaply, and Bidness Etc recommends investors pick it up.

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