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VMware’s M&A Strategy Looks Spot On

Tom Taulli

It has definitely been a stellar year for enterprise cloud stocks. Just look at companies like Anaplan (NYSE:PLAN), Okta (NASDAQ:OKTA) and Docusign (NASDAQ:DOCU). They have all posted over 80% returns.

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But the news has not been as good for old-line enterprise companies, especially those that rely heavily on on-premises solutions. One example is VMware (NYSE:VMW) stock. Consider that the return is a measly 10.6%.

Founded in 1998, VMware is the pioneer of virtualization for the x86 architecture, allowing for much better performance from existing machines. But with the secular trend towards the cloud, the business has come under pressure. For the most part, there has been a move away from traditional virtualization to the use of containers that hold apps, configurations and settings.

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Interestingly enough, the origins of this technology go to Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG), which needed to find ways to scale their cloud applications. The company’s engineers developed a framework, called Kubernetes, that allows for this. About five years ago, Google open sourced this, making the technology a standard.

Now while containers and Kubernetes are clear threats to VMW stock, it’s important to keep in mind that the company is not sitting back. That is, there has been a big push for M&A, including about $5 billion in recent deals for Pivotal Software (NYSE:PVTL) and Carbon Black.

So why these companies? Well, let’s take a look:

Carbon Black

Carbon Black, which is a cybersecurity company, came public in May 2018 at $19 a share. VMW agreed to buy the company for $26 per share.

For the most part, this deal is about expanding the footprint. No doubt, cybersecurity is a top-of-mind priority for companies. The risks keep increasing as new technologies like cloud and mobile penetrate the enterprise. Regarding Carbon Black, its technology is targeted on endpoints, whether physical or virtual where sensitive data is located. The company has also been leveraging next-generation approaches like AI (Artificial Intelligence).

With the deal, VMware will launch a new Security Business Unit. And it should represent a nice avenue for growth and cross-selling.

Carbon Black has over 5,600 customers and reported a 19% increase in revenues during the latest quarter to $60.9 million. Although, the cloud revenues jumped by 68% to $22.9 million.


Pivotal Software

Pivotal Software is another recent IPO that came out in April 2018. The initial offering price was $15, which is what VMware ultimately agreed to pay for the company.

Pivotal Software operates a software platform that helps with the building, deployment and operation of cloud-native and legacy applications. But the company has also been leveraging its technology with Kubernetes. Pivotal Software has launched an alpha version of its Pivotal Application Service (PAS) for this. Then there was a partnership with VMware last year for the Pivotal Container Service, which allows for scaling Kubernetes.

True, the growth rate for Pivotal is not too impressive, at 17% during the latest quarter. But like Carbon Black, the cloud business is growing quickly, at 38%. Consider that Pivotal believes its market opportunity is $50 billion.

Bottom Line VMW Stock

While VMware’s M&A strategy is risky, it’s the best way to transition to the cloud. What’s more, the dealmaking will likely continue. As seen with other mature tech companies like Adobe (NASDAQ:ADBE) and Microsoft (NASDAQ:MSFT), the transformation process can result in strong gains for shareholders.

Oh, and for VMW stock, the valuation is currently at fairly cheap levels, with the price-to-earnings ratio at only about 9x. So for investors looking for an interesting value play, this one fits the bill.

Tom Taulli is the author of the book, Artificial Intelligence Basics: A Non-Technical IntroductionFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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