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Breaking Analysis: Assessing Dell’s Strategic Options with VMware

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>> From theCUBE Studios in Palo Alto and Boston, connecting with thought leaders all around the world, this is a Cube Conversation >> On June 23rd, the Wall Street Journal reported that Dell is exploring strategic options for its approximately 81% share in VMware

Both Dell and VMware stocks popped on the news We believe that Dell is floating this trial balloon to really gauge investor, customer, and partner sentiment And perhaps send a signal to the short sellers that, you know what, Michael Dell has other arrows in his quiver to unlock In case you want to squeeze me, I'm going to squeeze you back Who knows? Hello everyone, and welcome to this week's Wikibon CUBE Insights, powered by ETR

In this breaking analysis, we'll unpack some of the complicated angles in the ongoing VMware saga, and assess five scenarios that we think are possible as it pertains to this story As always, we're going to bring in some ETR customer data to analyze what's happening with the spending picture Let's take a look at what happened and just do a quick recap The Wall Street Journal's story said that Dell was considering spinning off VMware or buying the remaining 19% of VMware stock that it doesn't own, hmm The Journal article cited unnamed sources and said that a spin off would not likely happen until September 2021 for tax reasons

That would mark, of course, the five year anniversary of Dell acquiring EMC, and would allow for a tax-free transaction Always a good thing What's going on here, and what options does Dell really have? What does it mean for Dell, VMware, customers, and partners? We're going to try to answer those questions today So, first of all, why would Dell make such a move? Well, I think this tweet from Yaron Naymark He's a portfolio manager at 1 Main Capital

It kind of sums it up He laid out this chart, which shows Dell's market cap, prior to the stock pop It's closer to 38 billion today, and the value of its VMware ownership, which is over 50 billion since the stock pop But, let me cut to the chase Investors value the core assets of Dell, which accounts for around $80 billion in revenue when you exclude VMware, somewhere south of negative $10 billion

Why? It's because Dell is carrying more than $30 billion of core debt, when you exclude Dell Financial Services, and it looks like a conglomerate owning the vast majority of VMware shares Michael Dell has something like a 97% voting control Core Dell is a low margin, low growth business Some have complained that Michael uses VMware as his piggy bank, and many investors just won't touch the stock So, the stock, generally Dell stock, has underperformed

I've often said, even going back to the EMC days, that owning the stock of VMware's owner is actually a cheap way to buy VMware, but that's assuming that the value somehow gets unlocked at some point So, Dell is perhaps signaling that it has some options and other levers to pull, as I said, maybe trying to give pause to the shorts Now, let's have a look at some of the ETR spending data and evaluate the respective positions of Dell and VMware in the marketplace This chart here uses the core ETR methodology that we like to talk about all the time For those not familiar, we use the concept of net score

Net score is a simple metric It's like net promoter score, sort of The chart shows the elements of Dell's net score So, each core to ETR goes out and asks customers, "Do you plan to adopt the vendor new?" That's the lime green at 4% "Spend more relative to last year?" More, meaning more than 6%

That's the forest green, and you can see that's at 32% Flat spend is the gray, meaning plus or minus 5% And then, decrease spending by 6% or greater That's the pink, and that's 11% for Dell Or, "Are you replacing the platform?" See that, that's the bright red there at 7%

So, net score is a measure of spending momentum and it's derived by adding the greens and subtracting the reds And you can see Dell in the last ETR survey, which was taken at the height of the pandemic, has a net score of 18% Now, we colored that soft red It's not terrible, but it's not great either Now, of course, this is across Dell's entire portfolio, and it excludes VMware

So, what about VMware? So, this next graphic that we're showing you, it applies the exact same methodology to VMware And as you can see, VMware has a much higher net score at 35%, which of course shouldn't surprise anybody It's a higher growth company But 46% of VMware customers plan to spend more this year, relative to last year, and only 11% plan to spend less That's pretty strong

Now, what if we combined Dell and VMware and looked at them as a single entity? Hmm, wouldn't that be interesting? Okay, here you go So, there were 975 respondents in the last ETR survey when we mashed the two companies together And you can see the combined net score is 27%, with 42% of respondents planning to spend more this year than they did last year So, you may be asking, "Well, is this any good? "How does this compare to Dell and VMware competitors?" Well, I'm glad you asked So, here we show that in this chart, the net score comparisons

So, we take the combined Dell and VMware at 27% Cisco, as we often reported, consistently shows pretty strong relative to the enterprise data center players And you can see, HPE is a kind of a tepid 17% So it's got some work to do to live up to the promises of the HP, HPE split We also show IBM Red Hat at 14%

So, there's some room for improvement there also And you can see IBM in the danger zone, as we break that down, and Red Hat much stronger But, you know what, it's softened somewhat in the ETR survey since last year So, we'd like to see better momentum from IBM and Red Hat It's kind of unfortunate that COVID hit when it did, as IBM was just kind of ramping up its Red Hat go to market

Now, just for comparison purposes, for kicks, we include Nutanix Nutanix is a much smaller company, but it's one that's fairly mature And you can see at 52%, it's net score is much higher than the big whales Now, we've been reporting for months on high flyers like Automation Anywhere, CrowdStrike, Okta, Rubrik, Snowflake, UiPath These emerging companies have net scores north of 60%, and even in the 70% range

But, of course, they're growing from a much smaller base, so you would expect that Now, let's put this into context with a two dimensional view that we like to show Now, as you know, in addition to net score, that metric, we like to use so-called market share Market share is a measure of pervasiveness in the data set, or essentially market share in the survey, and it's a proxy for real market share So, what this chart here does, it plots several companies with their net scores on the Y axis and market share on the X axis

And you can see that we combined Dell and VMware together, and we plotted them in that red highlighted box just for comparison purposes So, what does this tell you about the competitive landscape? Well, first everyone would love to be AWS, Microsoft too We didn't plot Microsoft because they're so bloody dominant they skew the chart somewhat, but they would be way, way out to the right on the X axis because they have such a huge number of products and mentions in the data set, so we left them out Now, you can see VMware and Cisco, they're kind of right on top of each other, which is sort of ironic, as they're kind of increasingly overlapping with their offerings in the marketplace, in particularly NSX And you can see the other companies, and for context, we've added a few more competitors, like Veeam and Commvault

They're in a pretty strong position, as well as the combination of Dell and VMware So, let's start there Stifel analyst Brad Reback was quoted in the Market Watch publication as saying the following, "We have long believed Dell would ultimately buy-in "the approximately 19% or 125 billion of VMware "that it does not own in order to gain full control "over VMware's substantial free cash flow, "which is about $4 billion annually, "and we still expect this to be the ultimate outcome" I don't know, I'm not sure about this

On the one hand, you can see from the previous chart, this would be a better outcome for Dell from a competitive standpoint What it did is it pulls Dell up and to the right Yeah, but perhaps not so much for VMware, as it went down and to the left Dell would have to raise a bunch more cash to do this transaction And what, take on even more debt? Maybe it could get Silver Lake to finance the deal

Then, essentially Dell would become the Oracle of infrastructure It certainly would make Dell even more strategic to CIOs Would that be good for customers? Well, on the one hand I guess it would bring better integration between Dell and VMware, but I wonder if that's the critical issue for customers On the other hand, I think it would stifle VMware's innovation engine and a little bit further, and I wonder how Pat Gelsinger would react I mean, my guess, he would call it a day

And what about Sanjay Poonen, who's the obvious next in line for the CEO job at VMware What, he becomes the president of Dell's software division? And what about the rest of the team at VMware? They're a Silicon Valley stalwart, and that would slowly morph into Austin-based Dell With the debt burden growing, it's going to mean more of VMware's cash would go to paying down the debt, meaning less money for R&D or even stock buybacks, which you know I'm not a huge fan of And I'm not a huge fan of this scenario For sure, the technology partner ecosystem would be ice cold on such a deal

Although, you could argue they're already less than lukewarm But here, I want to explore some other options So, the next on the list is Dell could sell VMware to a private equity firm, or a strategic could basically wipe out its debt and have some cash left over to sail into the sunset That would be a big pill for someone to swallow Even though Michael Dell has 97% voting power, I think there's fine print that says he has a responsibility to protect the interests of the minority shareholders

So, to get approval, it would have to sell at a premium, and that could be as high as almost $70 billion Microsoft has the cash, but they don't need VMware Amazon, I guess, could pull it off, but that certainly is not likely Even if Google, who has the cash, were interested in buying VMware, Google would be the most likely candidate It would give Google Cloud instant access to the coveted enterprise, but it's really hard to conceive

I mean, same for a PE company 65 to 70 billion, they'd get their money out in 15 to 20 years So, I just don't see that as viable All right, what's next? How about the scenario of spinning off VMware that the Journal reported? So, in this transaction, Dell shareholders would get a bunch of VMware stock There may be some financial wizardry that Tom Sweet, Dell's CFO, and his band of financial geniuses could swing

I can't even begin to speculate what that would be, but I've heard there's some magic that they could pull off to pull some cash out of such a transaction And this would unlock the value of both Dell and VMware by removing the conglomerate and liquidity hangover for Dell, and it would definitely attract more sideline investors into VMware stock And Michael Dell would still own a boatload of VMware stock personally, so there's an incentive there So, this is interesting and certainly possible I think in a way, it would be good for VMware customers

VMware would get full autonomy and control over its destiny without Dell bogarting its cash So, it could freely innovate Dell would become probably less strategic for customers, so I don't think that for Dell EMC buyers, the technology ecosystem partners like HPE, IBM, NetApp, et cetera, they would like it more But they were already kind of down the path of looking to optimize VMware alternatives So, think about Cisco

But, I think for VMware customers, okay I think for Dell EMC customers, not so much Now, what about the do nothing scenario? I think this is as possible as any outcome Dell could keep chipping away at its debt, using VMware as a strategic lynch pin with customers Sure, they continue to pay the liquidity overhang tax and they'll frustrate some shareholders, who are going to remain on the sideline, but that's been the pattern anyway

Now, what about delevering some of the VMware ownership? So, the more I think about it, the more I like this scenario What if Dell sold 20% of its VMware stake, and let's say raised, I don't know, 10, $12 billion in cash that it could use to really eat into its debt burden A move like this, combined with its historical debt pay down, could cut its debt in half by say 2021 and get the company back to investment-grade rating, something that Tom Sweet has aspired towards This would drop hundreds of millions, if not a billion dollars to the bottom line, and it would allow Dell to continue to control VMware What I don't know, I don't know if there are nuances to this scenario

In other words, does dropping ownership from roughly 80% to about 60% trigger some loss of control or some reporting issue? I'm sure it's buried somewhere in the public filings or acquisition docs, but this option, to me, makes some sense It doesn't really radically alter the relationships with customers or partners, so it's kind of stable VMware maintains its existing autonomy It even somewhat lessens Dell's perceived control over VMware and it attacks Dell's debt burden Yeah, it's still a bit of a halfway house, but I think it's a more attractive, and I said, stable option in my view

Okay, let's talk about what to look for next It looks like the stock market is coming to the reality that we are actually in a recession, although it appears the NASDAQ is trying to ignore this Or maybe the market's a little bit off 'cause they're afraid Joe Biden's going to win the election and he's not going to be good for the economy We'll see We'll see what the economic shutdown means for tech companies in this earning season

ETR's next survey, it's in the field, and they're going to have fresh data on the impact of COVID going into the dog days of summer Here's what I think Let me give you my preview and we'll see in a few weeks how accurate it is I believe that tech spending is going to be soft broadly I think it's going to especially be the case for legacy on-prem providers, and I expect their traditional businesses to deteriorate somewhat

I think there's going to be bright spots in tech for sure, the ones we reported on Cloud, yes, absolutely Automation, I'm really looking closely at the battle between the two top RPA vendors, Automation Anywhere and UiPath I think there's a really interesting story brewing there And the names that we've been pounding like Snowflake, the security guys like CrowdStrike, and Okta, and Zscaler, I think they're going to continue to do very well with this work-from-home pivot

We also expect Microsoft to continue to show staying power, but because of their size, they're exposed to soft demand pockets, but I think they'll continue to be very, very strong and threatening to a lot of segments in the market Now, for Dell, I think the data center businesses continue to be a tough one, despite some of the new product cycles, especially in storage But I think Dell's continue to benefit from the work-from-home pivot, as I believe there's still some unmet demand in laptops We're going to see that, I believe, show up in Dell's income statement in the form of their client revenue I'd love to know what you think

You could tweet me @dvellante or you can always email me at davidvellante@siliconanglecom Please comment on my LinkedIn post I always appreciate that

I post weekly on siliconanglecom and on wikiboncom, so check out those properties And of course, go to etrplus for all the survey action

As they say, ETR's in the field with the current survey They got fresh COVID data So, we're excited to report on that in the coming weeks Remember, these episodes are all available as podcasts, wherever you listen This is Dave Vellante for theCUBE Insights, powered by ETR

Thanks for watching everyone We'll see you next time (upbeat music)

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