Stock rocket
News flash: Business is still growing by leaps and bounds at the software juggernaut VMWare Inc.
VMWare sells something called virtualization software that makes computer services operate more efficiently. It is one hot product. The company reported after the market closed yesterday that sales during the third quarter surged 90 percent to $358 million. Profit grew to $65 million, three times VMWare's earnings from the same period a year earlier, on a per-share basis.
VMWare went public this summer, and the stock took off like a rocket, climbing fast from its original offering price of $29 per share to more than $100. The latest financial report sent the stock over $108 in after-hours trading yesterday. As a new public technology stock, VMWare is the hottest thing since Google Inc.
Though VMWare launched its IPO to great fanfare in August, just a small portion of the company actually went public. EMC Corp. of Hopkinton continues to own about 86 percent of VMWare, and two strategic investors, Cisco Systems Inc. and Intel Corp., both hold small stakes.
Meanwhile, EMC will report its own financial results this morning. Most analysts believe EMC's own computer-storage business posted strong gains during the quarter, though not at a pace that could match VMWare. How the market reacts to both earnings reports matters to EMC shareholders.
EMC bought VMWare for just $635 million three years ago. Now, the public stock price implies that VMWare is worth more than $40 billion. The ballooning price of VMWare's public shares has changed the way people look at calculations used to put a price on EMC.
Add the value of EMC's own business and its VMWare shares. That should give you a fair value for EMC stock. But it doesn't compute if you assume that VMWare's public stock price is the right measuring stick. Investors are heavily discounting EMC's interest in VMWare, by 50 percent or more.
The public spin-off of VMWare has been a very good thing for EMC in general, pushing the market to give the company more credit for its fast-growing software unit. But the discount reflected in the two public stocks could become a problem if it continues to grow. Imagine an even bigger company buying EMC to acquire the storage business at fair value and a controlling interest in the market's hottest software company on the cheap. It's not very likely, but possible.
There are a handful of reasons why EMC can't get more credit from the market for its VMWare stake. The biggest is the impact of VMWare's tiny public float.
There are fewer than 38 million VMWare shares available for the enamored public to buy and sell. Add the hundreds of millions of shares owned by EMC to the float and the price would go down.
The VMWare float is even smaller than it appears because Fidelity Investments has been buying the stock like crazy and now owns nearly 9 million shares. Fidelity alone owns nearly a quarter of the public float, and it's not selling.
If this story sounds familiar, it is exactly the same aggressive strategy Fidelity used to buy as much Google stock as possible. Fidelity now owns more than 10 percent of Google.
"They learned a wonderful lesson from the tactic they used with Google," says James Lowell, publisher of the Fidelity Investor newsletter. "It's being used to lock up as much VMWare as they possible can."
EMC will never get full credit for its VMWare ownership, and it shouldn't. But the big discount is a problem EMC can't ignore.
BOSTON CAPITAL BLOG
Steven Syre is a Globe columnist. Read his daily blog at boston.com/business. He can be reached at syre@globe.com.
