Spinoff May Not Boost EMC’s Fortunes

08/27/2007 12:00 am EST


Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer, chief investment officer of Schaeffer's Investment Research, says the successful IPO of VMWare may not have much of a halo effect for parent company EMC.

[An article in Barron's on August 20th] notes the blockbuster success of EMC's (NYSE: EMC) initial public offering of VMWare (NYSE: VMW), which saw its stock soar 76% in its first day of trading. Meanwhile, parent company EMC saw its stock decline 3.7% that day.

The slide in EMC shares that came simultaneously with VMWare's debut is chalked up to mere investor capriciousness. "Most of the move in the stock was driven by investor excitement in the VMWare offering," says Tony Ursillo, an analyst at asset manager Loomis Sayles.

The author wonders at this phenomenon, noting that "buyers of EMC stock are getting VM shares at a price/earnings multiple of just 42x, versus the 66x the market is paying for VMWare shares outright."

Further, the article notes that VMWare holds 85% market share in virtualization software, and some analysts believe that EMC can benefit by providing its storage-area networks to companies that have implemented this server virtualization.

And the potential upside for EMC doesn't end there: "VMWare's 50% annual sales growth could add as much as five percentage points to EMC's yearly revenue growth, says Sanford Bernstein analyst Toni Sacconaghi."

This article tries its best to be bullish on EMC, but by the end of it, I was more impressed with VMWare. In many areas, it seems that EMC is simply feeding off the success of this division. Sure, the shares of EMC are more attractively priced-unless you're long EMC, in which case  "attractive" may not be the first word that comes to mind.

Additionally, the September 2007 $19 and $20 option contracts are the site of peak open call interest for the equity. Together, these two strikes play host to 61,671 contracts, which could provide a layer of options-related resistance to further gains in the equity.

Meanwhile, the bullish bandwagon is getting pretty crowded for EMC. Even post-IPO, the stock's Schaeffer's put/call open interest ratio is resting at an annual low of 0.28, and short interest represents less than 2% of EMC's available float-the former indicating a wealth of potential selling pressure that could unwind on the shares, and the latter revealing a lack of future short-squeeze potential.

Plus, the article admits it could be years before EMC can cash in on its precocious offspring: "Investors may be marking down EMC's stake because they realize that EMC won't sell any shares before 2009 in order to avoid taxes, rendering the asset illiquid."

It seems the author may have come to the same conclusion I did by the end of the piece, as it wraps up with this lukewarm endorsement: "But some day, VMWare's bright prospects will be reflected in EMC's financial results, and EMC's stake is likely to be better appreciated."

(EMC closed just below $20 Friday, while VMWare closed above $71-Editor.)

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