EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 EMC Corporation
The market leader in data storage, is currently storing untapped value
Company Description:
EMC is an information technology company that offers clients a variety
of information storage products and services to help enterprises build web-based
computing systems. It designs hardware and software, which allows businesses
to store, manage, protect, and analyze massive quantities of data. In addition to
data storage (EMC’s core), it offers data security through its RSA sub-segment,
a data analytics platform through its Pivotal acquisition, and virtualization
through VMware (80% ownership). VMware is a leading provider of
virtualization and cloud infrastructure products, services that help clients
aggregate multiple servers and networks together into shared pools of capacity,
increasing efficiency and manageability.
Investment Thesis:
My Buy recommendation is based both on EMC’s long-­‐term exposure to global macro-­‐economic trends and its current discount valuation. • Through acquisitions and internal development, EMC has assembled a complete portfolio of products and services that will allow its market-­‐leading install base to capitalize on the next big macro-­‐
trends in IT. EMC has labeled these trends the “Third Platform” and they include Cloud, Big Data, Mobile, and Social. • Currently, EMC stock is undervalued, since management has yet to capture the full value from its positioning VMware, despite growing revenue. This undervaluation is supported by both a DCF and Sum of Parts models as well as by the largest positions recently taken by two big activist investors. • In the short-­‐term, I see a spin-­‐off or sale of VMware unlikely, but the increased pressure should benefit the stock as management makes moves to better capture and return value to shareholders. BUY EMC Corporation
Target Price: $36.20 Current Price: $30.38 Total Return: +19.2% Ticker: EMC Market Cap: 61.606b Dividend Yield: 1.5% Shares Outstanding: 2.057b 52-­‐week range: $23.15-­‐$30.39 1 Year Price Valuation Metrics P/E: 21.84 P/S: 2.56 P/B: 2.72 EV/EBITDA: 10.11 EV/Sales: 2.43 Risks:
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A poor macro-­‐economic environment that would adversely affect IT spending. The commoditization of core storage through white box servers and open source storage. Increased competition, epically from software-­‐only providers like Amazon’s Web Based Service and Microsoft’s Azure. CEO Succession, as Joe Tucci is 67 years old and is expected to retire in 2015-­‐2016, but no succession plans have been announced. 1 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 Table of Contents
Company Overview ………………………………...………………………………….. 1
Segments ………………………………………………………………………….1
Business Model …………………………………………………………………...2
Competition ……………………………………………………………………….3
Current Issues: A Value Disconnect……………………………………………... 3
Recent News: Activist Investors Take a Position 4
Investment Thesis: .……………………………………………………………………. 5
Economic Environment ……………………………………………………….….5
Industry Trends & Catalysts ………………………………………………..…….6
Valuation: .………………….………………………………………………………….. 9
DCF Mode………………………………………………………….……………. 9
Sum of Parts Model ……………………………………………………………..11
Modeling the Effect of Activist on Valuation……………………………………13
Risks: .……………………………………..…………………………………………. ...14
Conclusion: .…………………………………..………….…………………………..... 15
Works Cited: ………………………………………………………………………….. 15
Appendix A: Complete list of Products & Services Offered…………………………….16 Appendix B: Income Statement Forecasts……………………………………………….17 Appendix C: DCF……………………………………………………..………………….18 Appendix D: Sum of Parts…………………………………………………...………….19 2 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 COMPANY OVERVIEW
EMC’s sells its products and services to a variety of enterprise customers, from
Fortune 500 corporations to small business. They sell to a variety of industries, but their
tops are financial services, government agencies, internet service providers, and
manufacturing companies. EMC’s business has a global reach with about half of revenue
coming from outside the US: 55% US, 25% EMEA, 15% Asia-Pacific, and 5% Latin
America. EMC markets its portfolio of products and services both directly with an
internal sales force and indirectly with outside partners; about half of sales come from the
sales force while the other half comes from a network of distributors, system integrators,
resellers and OEMs. EMC’s most valued customers are IT wholesalers Ingram Micro Inc.
(IM) and Tech Data Corp (TECD), which are responsible for 5.26% and 3.16% of total
revenue respectively. From a direct sales side their most valuable customers are Intel
(INC), Exxon Mobil (XOM), Chevron (CVX), AT&T (T), and Verizon (VZ)10. EMC
also relies on strategic partnerships and “coopetition” such as its 80% ownership of
VMware and strategic partnership VCE. VCE is a joint venture with Cisco, Intel, and
VMware that builds and markets complete converged infrastructure systems using
hardware and software from each other. EMC refers to its loose structure of multiple
businesses as the “Federation Model,” and it has become a hot topic among a few
activists looking to break it apart.
Segments:
EMC’s reporting segments include the stand-alone EMC business (EMC
Information Infrastructure), which is further sub-divided into Storage, Information
Intelligence, and RSA Security, and the other federation members, VMware and Pivotal.
Storage, EMC’s core and largest segment, can further be broken down into High-end,
Emerging, Backup, and Professional Services, but it does not report along those lines.
The breakdown of the Federation is below, and a complete list of all products and
services offered by category is in Appendix A.
1 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 EMC Information Infrastructure: (76% Rev, 70% Profit)
o Storage (69% Rev)
§ High-End Storage: EMC’s core traditional network storage
architecture and converged infrastructure products (all-in-one
bundles)
§ Emerging Storage: Recent innovations like flash storage arrays,
Software-Defined-Storage (SDS), unified storage, and Cloud
storage
§ Backup: Recovery, archiving, and back-up services
§ EMC Global Services: EMCS’s consulting wing
o Intelligence (3% Rev)
§ EMC’s Enterprise Content Management (ECM) platform. Offers
document management services like integration, file sharing, and
synchronization.
o RSA Security (4% Rev):
§ Network Security Company acquired in 2006.
• VMware (22% Rev, 30% Profit)
§ A publicly traded company of which EMC acquired an 80%
ownership in 2004. Produced software center around Cloud
computing and server, network, and storage virtualization.
VMware software is a key component of EMC’s converged
infrastructure offerings.
• Pivotal (2% Rev, 0% Profit)
§ Spinout of a Joint Venture between EMC and VMware. Its
software creates a platform that utilized cloud computing for Big
Data analytics
Business Model:
•
EMC’s strategy involves utilizing its market leadership in the core storage
business while expanding into emerging technology. Network storage is an attractive
market because the systems support crucial business applications and store important,
often sensitive, information. The importance of such products results in high switching
costs, few substitutes, and low buyer power. CIOs/CTOs in the current environment tend
to be risk-adverse, meaning they are unlikely to switch systems and will pay a premium
for established, reputable vendors, thus making it one of the few markets in IT where it is
extremely difficult for start-ups to compete with established players9. The only downside
in this industry is that among the established players competition can be intense, and
some big name software companies like Amazon and Microsoft are beginning to enter
the market with software-only storage solutions.
EMC has an advantage in this industry due to its market-leading install base,
distribution network, and sales force. With 30% of the market share, it is the leader in
data storage with 34.3% share in ECB storage, 48% in NAS, and 24.2% in storage
systems11. EMC focuses on keeping clients and growing when customers upgrade or
2 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 expand their systems. EMC’s portfolio of offerings makes this easy because it uses more
standardized equipment, which lowers a client’s training and support costs. Moreover its
software is applicable across all hardware, so when a customer expands its storage it only
pays for the additional hardware while leveraging existing software. Finally EMC has a
wide product line, so a smaller customer can start with the lower-end offerings and move
up as its data needs grow.8 Another advantage is its size; no other storage company has
both the install base and scope of offerings of EMC. EMC’s larger competitors that can
match their size and scope are HP and IBM, but they are so large that they are weighed
down by corporate bureaucracy and restructuring. Smaller competitors tend to specialize
in a few niche areas of the storage market and lack the install base to sustain growth.
EMC is in the perfect middle where they can focus all their attention on the storage
market while being large enough to have the financial resources to purchase and develop
new technologies. The key to sustained success is staying ahead of innovation, and EMC
has benefited thanks to VMware, which has been one of the most influential enterprise IT
suppliers in the last decade8. Thanks to the success of VMware, EMC recognizes that
they can no longer sustain growth by expanding market share and so it has made it a
strategic priority to expand into businesses that can capitalize on the new trends in
technology. EMC has named these changes the “Third Platform of IT,” which includes
trends such as Cloud, Mobile, and Big Data. EMC has designed its portfolio of products
and service offerings to be well positioned to benefit long-term from these emerging
technologies.
Competition:
EMC’s main competitors are Hewlett-Packard (HPQ), Hitachi Data Systems,
IBM (IBM), and NetAp (NTAP). HP and IBM are large diversified technology
companies so are not of a comparable size to EMC; however they have large
relationships and large diverse portfolios to offer clients, and they also have a large
consumer side, which makes comparable ratios difficult. Hitachi has little US exposure;
they are mostly a competitor in Asian markets. NetApp is EMCS closest competitor from
an operational standpoint. NetApp also exclusively focuses on enterprise network
storage, but they are smaller on a revenue and market cap. While they have expanded into
converged infrastructure, they do not have the full offering comparable to EMC’s
Federation model.
Current Issues: A Value Disconnect
EMC stock has become attractive due to the apparent valued disconnect among
the federation model, especially between EMC and VMware. Over the last two years
EMC stock has been virtually stagnant, even during the current bull market, while
VMware common stock has experienced significant growth. Examination of the financial
statements reveals that both EMC and VMware have experienced revenue and operating
income growth over the same time period. While I acknowledge that the poor macroeconomic IT spending environment has also contributed to keeping investor sentiment
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Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 low on infrastructure names, it appears to me that if one wanted a play on virtualization it
would be significantly cheaper to buy EMC stock than publicly traded VMware, since
one would practically be getting core EMC for free. EMC share of VMware are being
more heavily discounted than publicly traded VMW shares7.
Recent News: Activist Investors Take a Position
Within the last 6 moths two big activist investors Elliot Management (Paul
Singer) and Green light Capital (David Einhorn), have also taken note of this disconnect
and have taken large positions in EMC, about 44M shares and about 6M shares
respectively12, 5. They believe EMC trades at a significant discount because of the
federation structure and are looking to break it up by spinning off VMware. They feel
that the current model is not capturing the total value of all assets but rather creating dissynergies. They cite extremely high corporate reconciling costs, duplicated R&D
expense, misaligned incentives, suboptimal board composition, and questionable
synergies across the federation as all contributing to the lagging share price2. CEO Joe
Tucci, who at 67 is in the twilight of his career, will sometime soon step down and new
management could more persuaded. Also activists note that there was positive reaction to
recent tech spin-off announcement at HP and EBay.
While short term I can see that the structure may not be the most beneficial, I
believe that despite the pressure, EMC will not let go of VMware. VMware has become
too strategically important, which can be seen by the key role that its software plays in
both the VCE joint venture and the hybrid cloud systems. Core EMC is still growing and
is undervalued, so management will look for more ways to unlock shareholder value.
While VMware is of critical importance for EMC’s next generation platform, they have
never fully captured the value associated. While a split would help shareholder returns in
the short-run, it fails to anticipate what is likely to be increasing synergies between the
two companies over time. VMware software is crucial for converged infrastructure and
hybrid Cloud so as these new areas of storage come to replace traditional VMAX, EMC
will be able to realize increased synergies long-term.
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Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 INVESTMENT ANALYSIS
Economic Environment:
The IT storage industry is typically very cyclical and follows the overall health of
the economy and GDP. The largest single economic indicator of profitability is enterprise
IT spending, which in turn is generally reflective of the health of the overall economy,
because when companies are performing well fiscally, CIO/CTOs tend to have larger
budgets9. The chart below shows the 10-year performance of EMC stock against the
International Data Corporation’s (IDC) total IT spending index (TOITTOTL) and Total
IT spending US index (TOITSSUS). The graph shows that throughout economic cycles,
the stock generally rises and falls along with spending. Coming out of the recession, IT
spending increased significantly 7.14% from end of 2009 until beginning of 2012, when
it tapered off to a 3.7% gain. EMC stock also boomed coming out of the recession
growing 11.04% annually but has had no real positive price appreciation since 201210.
During the last two years, while total spending has declined, contributing to the
deceleration in total spending growth, storage spending increased 3.7% in 2012 but
declined 1.4% in 2013, with 2014 thus far following a similar trend13. The decline can be
attributed to a prolonged cyclical slowdown in capacity, bad timing on product cycles and
constrained budgets. In general, systems are being run longer due to shrinking budgets,
firms are focusing on cost saving and optimization, and they are only spending as much
as they have to in order to stretch out the life and efficiency of their current platforms.
Surveys indicate that firms are patiently waiting for the next big thing before making big
decisions about upgrading and expanding new infrastructure. Surveys also show that
when that time comes, CIO/CTOs should be armed with plenty of funding, since the last
couple of years they have proven their ability to increase efficiency and operation
effectiveness with smart IT spending and are earning the trust of CFOs and CEOs.
5 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 My hypothesis is that “Third platform” products will be catalysts to jumpstart
storage spending and drive EMC stock up to its normal position relative to total IT
spending. Such offerings are both innovative and cost efficient. A recent IDC study on IT
spending confirms my hypothesis. According to their survey Big Data spending (an area
in which EMC has positioned itself well) is expected to increase 31.7% annually to
$23.6B by 201613. Of that $23.6B $6B will be spending on storage alone, second largest
beneficiary after disk systems. Big data spending is currently around 16% of total IT
spending, but they estimate that by 2018 big data will account for 41.5% of total IT
spending13. Overall the IDC has a positive future outlook on IT spending and believes
that “Global Phenomenon” like Big Data can push total IT spending to a 4.5% CAGR
through 2018, higher than the projected sub-4% pace of expansion for global economy13.
Industry Trends & Catalysts:
EMC has named the big trends in enterprise storage the “Third-Platform,” which
is the transition from a linear client/server model into the interconnection of Cloud,
Mobile, Social, and Big Data.
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Cloud Computing:
o Cloud computing is the term used to refer to a group of remote servers
networked together to create a larger centralized pool of capacity for data
storage, applications, resources, and other services all accessible from
multiple devices. Clouds are public, private, or hybrid.
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Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 •
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o EMC has multiple Cloud plays among their offerings. Driving sales in the
High-end storage segment recently is Isilon, EMCS’s clustered storage
infrastructure for public and private clouds. In the Emerging/SDS segment
EMC has a hybrid cloud solution, Cloud Foundry, which is a softwaredefined data center approach that helps customers form very efficient
private clouds that work seamlessly with a wide choice of compatible
public clouds. This hybrid cloud approach gives customers more control
over their IT, more flexibility, more choice and lower costs. Cloud
Foundry is growing as an industry standard because of its open source
software development model4. The VCE strategic partnership that offers
converged infrastructure products named Vblocks offers a complete all-inone cloud-based system. Finally, VMware’s core virtualization technology
is a specialized application of Cloud computing7.
o Converged Infrastructure: converged infrastructure is the grouping of
multiple IT components into a single, all-in-one, optimized computing
package often consisting of servers, storage devices, networking
equipment and software. CI can be divided into infrastructure and
platform. VCE’s Blocks are integrated infrastructure, which are more
general purpose than platform integration. The broader market opportunity
makes infrastructure CI an area of tremendous growth. According to
IDCD, revenue in this market increased 63% YtoY from 2013 and will
expand 39% in 2014; by 2017 revenue estimates are $11.2B, well above
platform. It is considered the fastest growing CI category with a 43%
CAGR from 2012 to 2017. VCE market leader in converged
infrastructure, 33% CAGR will reach $14.7 Billion in 20177.
Big Data:
o Big Data is the general term used to refer to the collection of massive data
sets that are so large and complex that one can longer use the traditional
methods of storing, archiving, analyzing, arranging, organizing, capturing,
searching, sharing, transferring, visualizing, and protecting. Recent trends
brought about by advancement in technology have made computing
devices smaller, cheaper, faster, more powerful and with larger storage.
Corporations and other entities are beginning to realize the efficiency
gains of data analysis and are taking measure to gather and store more
data.
o EMC has a wide exposure to Big Data. Pivotal functions in a platform-asa-service model focusing exclusively on software and strategic services
with differentiated technology in big data analytics. EMC’s core
information infrastructure business offers Big Data storage, servers and
hardware that work with the Pivotal analytics services. EMC’s Big Data
products and services help clients to ingest huge amounts of data quickly,
reason over it, and act on it in real time.
Mobile:
o In the third platform, mobile does not just refer to cell phones but any
small device, not just a traditional desktop PC or laptop, that can access
the internet and send, receive, and store data. This includes not just phones
7 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 and tablets but wearables, RFDs, sensors, and the broader “internet of
things” (IoT) market. It contributes to the phenomenon by exponentially
increasing the amount of data available that companies can store and
analyze while also creating multiple devices to access such data and
multiple access points, increasing the need for management and security
of data networks. This includes any sensor device that generates data for
manufacturing, inventory management, and healthcare.
o EMC befits from the mobile/IoT trend not through direct manufacturing
but increased demand for data storage and demand for smaller size. The
expansion of smaller computer devices not only creates more data that
needs to be stored but also smaller storage devices. The increased number
of access points provided by mobile devices also increases demand for
security.
Hybrid
o While not explicitly part of the “Third Platform” hybrid technology fuses
other technology, like private and public clouds with a more open source
design so that they are compatible with other competitors offerings. It is
an important strategic step to address increased competition from
software-only players who can now enter the storage market through the
Cloud. The big announcement from EMC’s 3Q conference call was a
hybrid cloud strategy: Enterprise Hybrid Cloud Solution. It offers EMC
storage and converged infrastructure that is compatible with multiple
public cloud providers. Current packages are compatible with VMware
vSphere, Microsoft Azure and packages compatible with Amazon’s Web
Based Services and Open Stack are coming next year1.
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Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 VALUATION
DCF Model:
The best way to capture the future earnings potential of EMC is with a discounted
cash flow model. Below is the rationale behind my income statement forecasts; the
projections themselves can be found in Appendix B and the actual DCF can be found in
Appendix C.
Income Statement Forecast by Segment:
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Information Storage
o High-End: Driven primarily by the core VMAX system, this segment is
beginning to see large declines YoY as products mature. After a bad
minus 7% quarter, the release of VMAX 3 for 4Q should end the year on a
positive note. The VMAX 3 will last through 2015 and is responsible for
about half of all high-end storage sales. However moving forward this
segment is not a sustainable driver of growth, and EMC is aware of such.
o Emerging: Isilon, Viper, and Xtrem are the key offerings and drivers of
future growth. This segment is set to benefit most from “Third Platform”
infrastructure. Strong 3Q was up 47% and the category is now almost 60%
the size of the high-end segment. Management noted that Xtream, the all
flash arrays, are preferred by customers building out mobile strategies and
Isilon has seen multiple quarters of 100%+ YoY growth, quickly
becoming a flagship product.
o Backup: largest single driver is VNX in unified storage and Data Domain
in backup. 3Q grew 6% YoY marking 4 straight quarters of above 3%
growth, higher than the overall backup/recovery market. Management still
believes there is more market share to be gained. The segment should be a
consistent performer as it slowly continues to gain share.
o Storage Overall: Storage is at a crossroads where the core high-end
storage is maturing while emerging storage is driving significant growth,
and backup remains steady. A strong 4th quarter led by a refresh in highend will make up for some lagging earlier in the year, and I project total
revenue will increase 3% for 2014 and 4% for 2015 before emerging
storage too catches up with high-end, and growth will reach 7% for 2016.
Margins should remain in the 23% range for 2014, but as more revenue
comea from the higher margin emerging segment, overall margins should
slowly expand to 25% by 2016.
Information Intelligence Group
o This Group includes EMCs multiple Enterprise content Management
offerings. It not a strategically important segment, and sales have been
declining as the market becomes saturated. However, the 1st half of 2014
has seen growth in service revenue, as the install base opens up to the
9 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 relatively cheap services. I see no reason to vary from consensus which
grows revenue along with the installation base at about 3%
RSA Security:
o This segment has some of the highest growth potential. The key driver
moving forward is analytics in security, now a third of total segment.
Current events like the heat bleed bug, Target, EBay, and Home Depot
data breaches are raising awareness of the need for such a platform. Thus
far 2014 has been slower than usual; I forecast a 5% growth rate before
pickup to double digits 13% and 16% in 2015 and 2016 respectively.
Pivotal:
o This segment had strong double-digit growth in first half 2014 that
exceeded estimates. Recently it underwent a re-structure to re-brand the
platform as a “software-as-a-service” model. This new model shifts
revenue to a subscription basis, so revenue should be more consistent
moving forward. As a result of the switch 1Q revenue was extremely high,
and everything since has been much lower. Because of the transformation
to a subscription service model, 2014 should end negative, I forecast
around -10%, but it should jump back up to double-digit revenue growth
of 14% and 17.5% as bookings increase. Long-term I am optimistic about
Pivotal because it should be the primary beneficiary of the Big Data trend,
and open source nature of cloud foundry analytics gives it a competitive
advantage to other Big Data analytic offerings.
VMware:
o First three quarters of 2014 have maintained double-digit growth. I
forecast the momentum to continue at 16.5% and maintain a 17.5%
growth until 2016. VMware has actually been benefitting from the poor
macro economic environment of stalled IT spending that has been hurting
EMC. While enterprises are putting a pause on storage spending,
upgrading, and refreshing, they have been instead focusing their tight
budgets on cost savings initiatives, and they are realizing the efficiencies
and cost saving that virtualization offers. However, virtualization
infrastructure is in the later innings of growth, so the future will rest in
utilizing existing VMware hardware and software in hybrid clouds
through VCE. This is one reason why the strategic alliance with EMC is
so important and why it appears that EMC has been holding back VMware
during the current economic cycle. I also forecast slight margin expansion
(30% to 34%) as the higher margin Vblocks and other converged
infrastructures become a larger source of total revenue.
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DCF Model Assumptions and Forecasts:
My forecasted terminal growth rate is 3.5%. While IT spending had been below
3%, EMC’s revenue has been growing above that of the industry, and as we enter the
“Third Platform” within the next 10 years, companies should begin spending above GDP
like they did in previous cycles. I used is 9.5% as the long-term discount rate. Such a rate
is low for Tech as a sector but EMC warrants it because they are an established,
10 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 reputable, low risk company. While their business is cyclical, it is still less cyclical than
consumer technology, where, unlike IBM and HP, EMC does not have any exposure. Its
long history and low leverage makes it overall a less risky company. As a reface point
Bloomberg estimates its cost of equity at about 9% and its Beta as less than the market at
about .91. Long-term I do not see operating margins expanding much beyond 21% as
there is the growing problem of margins pressure cause by white-box storage systems.
For tax rate and capital spending I used company guidance. I kept D&A relatively stable
and I modeled in management guidance of a decline in capital expenditures as they begin
to shift excess cash back to shareholders.
The final result of my DCF is a target price of $36.20, implying a +19.2% upside
to the current price of $30.38. Looking at the 10-year model I am comfortable with this
projection, since none of my forecasts seem unreasonable. I am roughly aligned with
consensus estimates for revenue and EPS in 2014 and 2015 and above consumers by
about $500m and $.08 for 2016 revenue and EPS. This is because I am a more optimistic
about the long-term global macro-trends in IT. My long-term growth rate of 3.5% is most
likely above consensus, but as stated earlier I think EMCs portfolio and improving IT
spending environment justify the rate. I am also comfortable with my discount rate and
growth rate as my terminal P/E and EV/EBITDA are 16.8 and 8.7 respectively which
falls on the lower end EMCs 10 year historical range of 36– 14, and 6.5-20.5
respectively10. Below is a sensitivity analysis of my model using various discount and
growth rates. I am comfortable with these rates and even at a sensitivity of +/- .5% the
DCF price would still be above EMC’s current price.
Sum of Parts Model:
Because of how large and diverse EMC’s offerings are, a sum of parts model can
pinpoint where the value is coming from and where it is not being utilized relative to
competitors. Below are the corresponding valuation multiples of key competitors used in
the model and an explanation of my methods while the model itself is located in
Appendix D.
11 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 •
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High-End Storage: Consisting mainly of the core VMAX and VNX storage
products. Because this business is very mature and experiences YoY decline, the
best valuation comparable would be a low value mature IT hardware asset, like
HP at .68
Emerging Storage: This is the area that has been driving the growth in storage.
Fusion-io (recently acquired by SanDisk) is a solid comparable that focuses
exclusively on flash similar to EMC’s Xtrem, and Nimble, a smaller network
storage start-up that recently went public. SanDisk/Fusion-io is probably the low
for this segment while Nimble is the high. I believe that with their advances in
scalability and new products, the emerging storage multiple should be closer to
Nimble, but it won’t quite reach Nimble due to size, and that Nimble probably has
an M&A premium factored in. for the model I used a multiple equal to Nimble -1.
Backup/recovery: closest comparable would be EMC’s top competitor NetApp,
as both have experienced similar growth in the 2%-3% range.
Information Intelligence: EMC’s enterprise content management offerings. Due
to the diversity of the different offerings there is no one company with similar
products services, the best estimate is an average of Pegasytems, Open Text, and
Kofax, all of which focus on different aspects of information management.
RSA: the security business is most aligned with Symantec. Symantec is a leader
in data security; it recently announced that it will split into two companies, one to
focus on security, the other information management. RSA warrants a similar
multiple.
VMware: For simplicity’s sake I used a multiple .8 times that of publicly traded
VMware to represent EMC’s 80% ownership. I also subtracted VMware cash
from EMCS for the net adjusted cash portion of enterprise value.
Pivotal: Without a good comparable I used a prior transaction. When GE bought
a 10% stake they estimated that it would be a billion dollar business by 20172. I
used that billion estimate and discounted it back three years to 2014 using the
same discount rate as the DCF to find Pivotal’s current enterprise value.
Overall the sum of parts model gave me a target price of $35.05, 15% upside on
current price. While it is a slightly smaller target price than my DCF, it confirms
my hypothesis the as the company currently stands today, it is undervalued;
specifically it is not capturing the value from VMware that publicly traded
VMware is capturing in its share price.
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Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 Effect of Activist
on Valuation:
The increased interest from Activist is a positive for the stock for two reasons.
First it confirms my hypothesis from both the DCF model and the Sum of Parts model
that the stock is currently undervalued. Second it puts pressure on management to start to
return value to shareholders. After few years on multiple acquisitions and high R&D
costs, EMC is satisfied with where they have positioned their portfolio to benefit from the
“Third Platform” and are beginning to return cash to shareholders, via share buybacks
and dividends. Since the action, management has accelerated its buyback program to
repurchase $2 B of shares in the second half of 2014, and increased its quarterly dividend
by 15% to $.115 per share8. Total returns will now be $4B by the end of this year. The
outcome of the increase activist interest can have one of four effects3, as I outline below,
and none are truly detrimental to EMC stock.
1. No change in structure and no proxy fight, but increase in capital allocation
a. The best-case scenario where EMC maintains control of VMware and also
better capital allocation and more focus on synergies. It would drive value
in the immediate term while keeping their long-term exposure to emerging
trends. The only risks would be the same macro-economic risks the
company faces now.
b. The price would go up to $35.00 immediately, the price of my Sum of
Parts Model.
c. Raymond James analyst Brian Alexander estimates this scenario as the
most likely 65%, while I think it’s even higher (75%) as it is a win-win
and avoids the costs and time of a proxy fight3.
2. Unsuccessful proxy fight
a. This is probably the worst-case scenario. After an unsuccessful proxy the
bad press will likely drive the stock price down. However it is not that
bad, since EMC will retain control over VMware and still have exposure
to their long-term growth drivers
b. Price would fall to the pre-activist trading range ($24 - $28) 10.
c. Alexander estimate’s this outcome second most likely but only 15%-20%3
3. Tax-free spin off of VMware, use fund for share repurchase
a. This scenario is best best for the stock in the short-term as it creates
immediate value, is tax efficient, and eliminates the structure dissynergies. The downside is it would affect the long-term strategic
positioning, but keeping the “Coopetition” partnerships like VCE and
hybrid cloud would keep some exposure. The big risk is if VMware gets
acquired by a competitor.
b. Price moves beyond sum of parts with additional cash flow and simple
organizational structure to $37.00
c. Estimates small chance this happens, 5%-10%3
4. Sell VMware
a. Would also create short-term value with buybacks and elimination of the
structure, but not as much as the spin-off because it would be tax
inefficient. Downside is it would create a lot of uncertainty
13 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 b. Not a lot of information about potential buyers or price, I estimate EMC’s
price would remain around $30.00
c. Same slim chance as a spin-off 5-10%3
Below is small model that takes the probability weighted effect of the four responses to
investor activism. I end up with $33.50, which is still above EMC current price,
suggesting that the net effect is positive in the short run for the stock
Senario
Effect on Price
Probability Wieghted
No change in structure
$35.00
75%
$26.25
Unsuccessful proxy fight
$26.00
15%
$3.90
Tax-free spin off
$37.00
5%
$1.85
Sell VMware
$30.00
5%
$1.50
$ 33.50
RISKS
•
•
•
•
•
•
•
•
•
•
•
The commoditization of core storage through white box servers and open source
storage
Poor macro-economic growth effecting IT spending
Slow acceptance of cloud based technologies, human skepticism of the cloud
Security
Emerging Competition such as Amazon’s Web Services in Cloud, Microsoft’s
HyperV in Vitalization and IBM’s smart Cloud in Big Data analytics. Additionally
those large incumbents have costly advantages over EMC/VMware
Constrained IT spending budgets driven by weak global GDP
Intensified competition as the industry become more consolidated and market share
gains begin to slow as competition increases
Additional competitions can lead to downward pricing. Risk additional pricing
pressures create need to innovate to preserve market share/ margins
CEO Succession plan, as Joe Tucci is 67 years old and the company has not
announced any succession plans but a 2015 retirement
Future M&A activity becomes more expensive because of more interested parties in
industry consolidation
The threat from white box suppliers and open-source alternatives could evolve over
time to replace storage
14 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 CONCLUSION
Based upon the careful analysis of the business model, economic environment,
industry trends, and multiple financial models, I am issuing a BUY on EMC corporation
with a target price of $36.00, resulting in a return of +19% over its current $30.00 price.
EMC has established a strong portfolio that is set to capitalize on the emerging “Third
Platform” macro-trend in IT. At the same time the stock is currently undervalued on a
sum of parts basis and activist investors are taking notice and applying pressure for policy
beneficial to shareholders.
Works Cited
1) EMC Q3 Earnings call, transcript pulled from Bloomberg by Alex Fullerton,
Management quoted: Anthony Takazawa, Joe Tucci, Zane Rowe, David Goulden
2) EMC, Raymond James Equity Research Report. Analyst Brian Alexander
3) EMC, Raymond James Company News Update “Activist Clash- Should it stay or
should it go?” Analyst Brian Alexander, Jeffrey Koche, Justin Patterson
4) EMC, Piper Jaffray Equity Research Report. Analyst Andrew Nowinski
5) EMC, RBC Capital Markets Equity Research Report. Analyst Amit Daryanani
6) EMC, Credit Suisse Equity Research Report. Analyst Kulbinder Garcha
7) EMC, Baird Equity Research Report. Analyst Jason Noland
8) EMC, Morning Star Equity Research Report. Analyst Peter Washlstrom
9) EMC, Hoovers Company Description. Analyst Jason Cother
10) Data Pulled from Bloomberg and calculated by Alex Fullerton
11) Gartner New Release, March 17, 2014 <>
12) “Activist Investor Pushes EMC to Break Up”, The Wall Street Journal ,Dana
Cimlluca, 7/21/2014
13) Bloomberg Data and Intelligence. Industry Overview Computer Hardware &
Storage and Global Application Software. Analysts: Mandeep Singh, Praveen
Menon, Anand Sinivasan, Eshani Gupte, Anrag Rana, and Charles Mead
15 | P a g e EMC
Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 Appendix A: Complete list of Products & Services Offered
• High-End Storage:
o
o
o
o
•
Emerging Storage/“Software-Defined Storage” (SDS):
o
o
o
•
VMAX: high-end scale-out storage
VNX: mid-range unified storage
VSPEX: EMC’s original Converged Infrastructure offering with Cisco
Vblocks: Converged Infrastructure offered by VCE, the joint venture with Cisco,
Intel & VMware that make complete cloud computing systems called
Isilon: clustered storage systems for digital content and other unstructured data.
Storage infrastructure for Public & Private Cloud & Big Data
ViPR: Software-defined storage platform, ViPR abstracts storage from disparate
arrays into a single pool of storage capacity that “makes it easier to manage and
automate its own data-storage devices and those made by competitors.”
XtremIo: all-flash and in-server flash arrays
Backup:
Data Domain: backup recovery, de-duplication
Networker: enterprise level data protection software that unifies and automates
backup to tape, disk-based, and flash-based storage media
o Mozy: Online backup service
o Recovery Point: Continuous data protection which supports asynchronous and
synchronous data replication
o Centera: makes software for document information processing and data capture from
paper and electronic documents and provides related services
Consulting:
o EMC Global Services: consultation, installation, training, customer support
Enterprise Content Management (ECM):
o Documentum: complete unified ECM platform for all content types. The platform
provided integrated business process management (BPM) capabilities as well as tools
for managing content across a distributed organization.
o Syncplicity: file share and synchronization service developed that lets users store and
sync files online between computers
o Captiva: Acquires information in the form of extracted content and files and then
delivers it for storage or workflow into document management systems such as those
from Documentum
Security:
o RSA: security analytics, governance, risk management, compliance, fraud detection,
identity verification
o
o
•
•
•
•
Virtualization: (Through VMware)
vPlex & vSAN: Storage Virtualization
vSphere: Server Virtualization
NSX: Network Virtualization
Horizon: Desktop Virtualization
vCloud: Application virtualization
vRealize: Data center and Cloud management
Data Computing:
o Pivotal: Data analytics based on cloud computing technology. Spin-out and JV of
EMC and VMware. Offers a integrated next-generation platform to support “Big and
Fast Data” applications
o
o
o
o
o
o
•
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Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 Appendix B: Income Statement Forecasts
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Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 Appendix C: DCF Model
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Analyst: Alex Fullerton fullerton.39@osu.edu 614-­‐596-­‐8971 November 18, 2014 Appendix D: Sum of Parts Model
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