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Shifting Strategy, Declining Guidance Unnerve VMware Investors

Published Wednesday, 30th January 2013 03:59 am - © 2013 Dow Jones

By Steven D. Jones

VMware Inc. (VMW) shares plunged as much as 22% Tuesday--erasing up to $9.4 billion in market value--as the software company deals with slowing growth in its core server virtualization business and modest returns from its campaign to virtualize the desktop.

The business trends prompted VMware to trim 900 jobs and lower its 2013 outlook for license revenue and total revenue. The company's guidance, typically conservative, still surprised analysts and raised the prospect that something was fundamentally changing with VMware's business, said analyst Brian Freed of Wunderlich Securities.

"VMware is in a much more competitive market," said Mr. Freed. "I don't expect VMware to dominate data center virtualization or desktop virtualization to anywhere near the extent they have dominated the server virtualization market."

For the first quarter, VMware projected license revenue between $480 million and $490 million, which was 10% below analysts' forecasts and down to levels last seen in the first quarter of 2009, at the depths of the recession, Mr. Freed said.

VMware has gone through three changes in pricing structure in the past 18 months while in the midst of launching a campaign to sell companies on its vision of the software-defined data center to complement its core server virtualization business. Two years ago, VMware launched a similar campaign to virtualize the desktop PC. Both initiatives put VMware in more direct competition with industry heavyweights such as Cisco Systems Inc. (CSCO), Microsoft Corp. (MSFT) and International Business Machines Corp. (IBM).

The competitive pressure emerged last year when there was a "noticeable pickup in promotions and discounts at the end of December," said analyst Richard Sherlund of Nomura Securities.

VMware's vSphere remains a leading server virtualization software, which makes servers work more efficiently. Microsoft's competing HyperV software isn't threatening VMware's popularity with large companies, but it "may be playing a role at the low end of the market," said Mr. Sherlund, who maintains a neutral rating on VMware stock.

VMware started in 1998, making software to create virtual computers that operate inside a single host computer, allowing users to get more power out of each machine. In 2010, it began acquiring software for email, presentations and social networking to build on the company's vision that more and more computing will move off the desktop and onto cloud services that VMware's technology makes possible. Cloud computing is being driven in part by employees who increasingly need to be mobile but still have access to everything they would have at the office.

While VMware remains the dominant player in server virtualization, its desktop virtualization business hasn't been a fast grower. The announcement that VMware would trim about 900 jobs, some of them in its desktop unit, indicate that the company is modifying that strategy. Steve Harrod, VMware's former chief technology officer and an architect of the approach, left the company last year to become a partner with venture firm General Catalyst Partners.

Instead of virtualizing the desktop, VMware is focusing on virtualizing the network, where it made several acquisitions last year, including a $1.2 billion deal for Nicira Inc. Its software builds virtual networks on unused network capacity similar to the approach VMware uses to create multiple computers on a single computer server.

The change in strategy also expands the market for storage hardware made by EMC Corp. (EMC), which owns roughly 80% of VMware.

"The move toward virtualization within the data center puts EMC in the driver's seat," said analyst Daniel Ives of FBR, who maintained his outperform rating on the shares. He urges investors to "see the forest through the trees." Virtual data centers will become a "fundamental growth story" in the future even though the shift is causing short-term anxiety about VMware in the present, he said.

Investors on Tuesday are having a hard time seeing that future. VMware shares recently fell 21% to $77.93, giving the company a market valuation of $33.3 billion. Earlier, the stock hit a new 52-week low of $76.33.

Write to Steve Jones at

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