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EMC Corporation Message Board

  • peristentone peristentone Jun 23, 2007 3:37 PM Flag

    How EMC Stock Could Fall After VMWare Goes Public

    So the big topic of conversation here seems to be will VMWare get a valuation of 10B or 20B post IPO. And then naturally everyone tries to calculate how far up this might push EMC's stock. Unfortunately, the calculations I have seen published here are based on a extremely fallacious assumption that EMC sustains the pre-IPO valuation on its intrinsic business, which almost certainly it will not. All of these calculations are failing to adjust the P/E on the earnings EMC will generate from its intrinsic business.

    Look at EMC's closest competitors, such as NetApp and IBM. EMC's intrinsic storage business is a boring, slow growing, old-technology business that gets its competitors P/E ratios in the 13 to 18 range.

    Let's assume that EMC post IPO grows earnings at $1B each year. The formula to get a rough calculation of EMC's post IPO share price would be the *new* P/E ratio for that $1B plus approximately 90% of the VMWare valuation.

    Let's assume the worst case, that post IPO EMC's intrinsic business is a P/E of 13, and that VMWare is at $10B market cap. That means EMC post IPO gets revalued to $1B * 13 + (.9 * 10) = $22B. That would be a very substantial drop in the current EMC share price, even with a very successful IPO.

    Now calculate the best case. EMC's intrinsic business is a P/E of 18, and VMWare gets a $20B market cap. Now you get EMC's post IPO price at $1B * 18 + (.9 * 20) = 36B. At that price the EMC shares essentially stand still even though VMWare blew the doors off the IPO.

    My personal opinion is my optimistic scenario is closer to the final outcome than the pessimistic one, but *for the short term* EMC has a fair valuation trading range $13 to $20. With the stock obviously making a move to test $20, the fundamentals here don't shout easy money.

    Now if EMC shares do move strongly lower *after* an IPO, and if you want some shield against a possible collapse in VMWare valuation if their growth rates stop, then EMC might make an interesting play. But for today it just looks to me like pure speculative walk on very thin ice.

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    • Your post is pretty confusing.

      A simpler calculation.

      Goldman Sach's analyst projects 18X multiple as fair value after IPO with an average earnings estimate of $0.8 for FY2008. That would suggest a fair value of $14.40 per share.

      That said, who knows how accurate estimates are for earnings growth of both EMC's intrinsic business and VMWare.
      NTAP has a p/e of 40 even after dropping the last few days. Even boring old Big Blue has a p/e of 17.

      I don't know what EMC's average p/e has been but based on Yahoo! it looks like its around 25 (it is currently 30). That is the real indicate of how the market has historically valued the company.

      Based on a p/e of 25, the fair market value (based on next year's earnings projections w/o VMWare) would be $20.

    • I can tell you exactly how an analyst would build a financial model for EMC going forward. First, they will take the cash flows associated with VMWare and EMC's intrinsic business separately, and adjust those to present values using some discount / interest rate. They will use the 10 year cash flow for VMWare, take 90% of that, and assign it to EMC. Then they will add in the value of EMC's 10 years of cash flows from its intrinsic business.

      Do the above for a best case, medium case, and worst case scenario. Then assign a probability to each case, multiply probabilities by expected outcomes, and you get a proability weight expected value, from which you can calculate share price.

      The above is how the professionals do it. And of course they never bother to share any of this with anyone, guarding it like a closely held secret.

      To answer your question more directly, no analyst would ever assign a P/E to a combined entity as you suggest. You could calculate such a number, but I don't think it is helpful in understanding the dynamics of what is happening underneath, which involves calculating the values of two very different businesses, then combining those together.

    • You didn't read my original message. My low and high value calculation for EMC stock contained two expressions:

      (.9 * 10)
      (.9 * 20)

      These are assignments of value to EMC for 90% of the low and high VMWare market caps of 10B and 20B respectively.

      So I never disagreed that EMC will get between 9B and 18B of the VMWare capitalization.

      The point is that the *remaining* valuation for EMC will be valued by the market at *lower* P/E ratio, which reflects the intrinsic cash generation ability of its legacy business.

      Probably you need to re-read my message from scratch and think about what I am saying there, because your response makes it look like you either didn't understand it or didn't read it entirely.

    • Good analysis...

      You do not mention two points.. One the Supplemental Revenue schedule lists Security Revenues of at least 500K for 2007, Also there will be a 800K dividend payable to EMC by VMN in the next 5 years.. With operating cash flows approaching 4 Billion per year in 2007; 20% + EPS will be attainable through buybacks and the current operations.. I see a mid $30's stock in FY 2010.

      • 2 Replies to eightpointbuck81
      • Please expand on this. How did you get to 4Billion cash for EMC's intrinsic business in 2007? If we take $1B income for 2007 (which is what you can reasonably extrapolate based on current income statement if you back out VMWare net income), then add in your 1.3B one-time, that gets us to 2.3B. Where did you get 4B?

        I did run a 10 year cash flow analysis for VMWare, but I'm the first to admit I don't know a lot about EMC's intrinsic business, other than what 30 minutes with financials online might tell you.

    • >Look at EMC's closest competitors, such as NetApp and IBM. EMC's intrinsic storage business is a boring, slow growing, old-technology business that gets its competitors P/E ratios in the 13 to 18 range.<

      Interestng in concept that you would memtion that it is boring, slow growing, old technology business when EMC uses the latest technology and continues to lead in equipment shipped. EMC has stated many times that the secret in storage is not the ability to store it but the ability to retreive it quickly when needed and the way to solve it is via software. What is your answer to boring, old technology when the storage market continues to grow? How would you store the data needed that requires almost imediate retrieval. I would like to hear what you would replace the equipment with and why?


      • 1 Reply to notsosimple11
      • Cars are extremely complex technically as well. Is the car business interesting if you want a growth stock? What does the technical complexity of a product have to do with the price of rice in China? We are talking about financial outcomes, not engineering.

        Storage businesses are not growing their bottom line rapidly. Unit sales expand rapidly while unit prices collapse rapidly as well. It's a very competitive business where several well entrenched players make good money but do not grow fast.

        So $1B in earnings on the storage business is nothing to laugh at. But it doesn't *grow* rapidly, and therefore it is likely to be assigned a lower P/E going forward.

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