VMware stock loses 33% on revenue miss

Investors punish firm for falling short of analysts' estimates

VMware Inc. went public at $29 a share in August and soared to $125 last fall, but failure to match Wall Street's forecast for fourth-quarter revenue shaved one-third off the company's market value yesterday. (Paul Sakuma/Associated Press)

VMware Inc., the virtualization software company controlled by Hopkinton's EMC Corp., was the computer industry's Cinderella story last year. Its stock soared after a 2007 public offering; so did sales of its software, which lets one computer do the work of many.

But VMware's shares were clobbered yesterday on news that the company's recent growth fell short of expectations. And with economic growth ebbing and software giants like Microsoft Corp. boosting their virtualization products, some VMware watchers foresee hard times ahead.

"This quarter and probably the next quarter are OK," said Trip Chowdhry, an analyst with Global Equities Research in San Francisco. "Six months down the road, things will get worse. After that, much worse."

VMware shares lost a third of their value yesterday, closing down $28.13 to $54.87. EMC, which owns about 86 percent of VMware, slumped $1.02, or 6 percent, to close at $15.89.

EMC chief executive Joe Tucci called the sharp drop in VMware shares "a hell of a reaction," and blamed it on a jittery market that's declined about 6 percent since the start of the year. "You've got a very fidgety market out there," said Tucci. He also noted that VMware only began trading last August, when EMC sold 10 percent of the company to the public. Originally priced at $29, VMware shares soared as high as $125 last fall, but drifted lower even before the earnings report. "It's a young company, it's only been trading for two quarters, and there'll be some volatility," Tucci said.

VMware released its fourth-quarter and year-end results Monday evening. Net income for the quarter came in at 19 cents a share, better than analysts' expectations. But while quarterly revenue was up 80 percent from the year before, analysts had predicted an 82 percent increase. They had also predicted VMware would see revenue growth of 56 percent in 2008. But VMware's chief financial officer Mark Peek told them to expect 50 percent instead, largely due to increased competition.

Corporations are hungry for virtualization because it lets them slash hardware and energy budgets. As a result, companies large and small are entering the market.

Microsoft plans to release virtualization software for server computers this year. But VMware must also compete against database software giant Oracle Corp. and virtualization offerings for the Linux operating system from Red Hat Inc. and Novell Inc. in Waltham. Then there's Lowell's Virtual Iron Software Inc., which targets smaller companies with a less-expensive line of virtualization products.

Chowdhry predicted companies that have already standardized around Microsoft, Oracle, or Red Hat products will see them as their first choices for virtualization software, instead of VMware. He also warned that customers would be put off by VMware's prices, which are often higher than the competition's. "As we speak, VMware has the best technology," Chowdhry said. "But is that best technology good enough for the customer to pay five times the price of another product? The answer is no."

Chowdhry wasn't alone in his skepticism. The investment firm of Caris & Co. downgraded VMware shares yesterday.

VMware spokesman Greg Eden said his company is well positioned to fend off rivals. "We finished 2007 with more than 100,000 customers," said Eden. "Companies of all sizes are standardizing on virtualization." Besides, he noted that Microsoft and other competitors are newcomers, and can't match the sophistication of VMware's products.

Brent Williams, an analyst with the Benchmark Co. in New York, agreed with Eden that VMware's competitors aren't much of a threat yet. "Microsoft's product is late to market," Williams said. "It's an unproven first-generation technology." He added that interest in Oracle's virtualization offering was "indiscernible."

Even the threat of a recession could be good news for VMware, said Williams, because virtualization helps companies slash computing bills. Williams retained his "buy" rating on VMware stock and expects it to climb to $90 this year.

Meanwhile, VMware's parent company, EMC, said both fourth-quarter and full-year revenues for 2007 climbed 19 percent to records. Fourth-quarter earnings of $525.7 million, or 24 cents a share, were 2 cents better than analysts' estimates. Revenue in the quarter was $3.8 billion. But Tucci warned of "a lot of uncertainty" in the year ahead. "I do believe we will see a bit of slowing in 2008," he said. "I'm not ruling out a recession." Tucci added that he doubted any downturn would halt economic growth worldwide. That would benefit EMC, which generated 45 percent of its fourth-quarter revenue outside North America.

Hiawatha Bray can be reached at bray@globe.com.