VMware (VMW) Cancels Virtustream Joint Venture with EMC

VMware, Inc.VMW has announced that it will not form Virtustream Cloud Services Business with EMC as announced this October.

VMware gained a lot of attention in the past few months since its parent company EMC Corporation EMC announced its acquisition by Dell, the deadline for which is just around the corner now.

What is the EMC-VMware-Virtustream Deal?

Along with their earnings release this October, VMware and EMC had announced plans to spin out Virtustream following the acquisition. The new company was expected to be owned jointly by EMC and VMWare with each having a 50% stake.

However, this news added to investors' concerns as Virtustream was still not profitable. A 50% stake would have required VMware to invest a huge amount for the development of hybrid-cloud solutions of Virtustream, which would weigh on VMware's financials.

All these concerns had together resulted in dwindling investor confidence in VMware, as can be seen from the fall in share prices. In the last three-month period, the company lost nearly 30% of its market cap in contrast to the S&P 500 index's gain of over 2%.

This loss led management to take some measures to regain investors' confidence as declining valuation of VMware would mean lower per share sale price for EMC investors at the time of the deal.

In fact, the speculations (of VMware retreating from forming a new Virtustream) started earlier this month when a Reuters report had stated that the company is re-evaluating the proposed ownership structure of Virtustream.

Virtustream was an important factor in VMware's valuation as the company had expected an operating loss of $200 million to $300 million in 2016 if it had formed Virtustream. However, Virtustream was expected to contribute significantly to VMware's revenues in 2016 with projected growth in the double-digits.

Dell-EMC Deal Details

According to the deal, EMC's stake in VMware (about 81% of the company) will be owned by Dell post the closure of the acquisition. VMware however, per the release, will continue to remain a publicly-traded company even after the acquisition.

An important thing to note here is that Dell will not be offering regular trading stocks for VMware. Instead, the company will be issuing a tracking stock that would reflect the performance of the trading stock. This will entitle EMC shareholders to have only economic interest in the trading stock but not own them (that is no voting rights or dividends). Most importantly, according to the deal, Dell will create tracking stock from 53% of the value of total VMware shares. Dell of course retains 80% of VMware shares and other shareholders the remaining 20%, which will be trading as usual. Dell will be paying EMC shareholders $24.05 per share in cash and approximately 0.111 shares of VMware tracking stock.

Through the EMC acquisition, Dell would be able to get a significant control of VMware at a much discounted price. As a result, investors have become jittery regarding the valuation of the company.

However, as per a Dec 11 update, Dell is considering buying back about $3 billion worth of VMware tracking stock.

Bottom Line

Despite backing out from the joint venture, the company's shares fell over 3% in Friday's trading session. Though VMware margins will now be less affected, revenues will likely come down for the company in 2016.

We note that VMware had already given a soft outlook for revenue growth in 2016 owing to the weakness in bookings.

It seems that such initiatives are not enough to regain investors' confidence amid the acquisition related uncertainty. We believe that management needs to explicitly lay out a growth strategy for VMware's core business, especially as headwinds from sluggish IT spending and stiff competition remain.

Currently, VMware has a Zacks Rank #3 (Hold). A couple of better-ranked stocks in the same space are Autodesk, Inc. ADSK and Cadence Design Systems Inc. CDNS , each sporting a Zacks Rank #1 (Strong Buy).

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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