EMC/VMware Spin-Out: New Shareholders Get Virtually Nothing

The EMC (EMC) announcement in February about spinning out VMware bothered me. At the time I said it kind of felt like the PeopleSoft Momentum spin-out 10 years ago but I couldn’t say why.

Now that EMC has filed an S-1, I have a better analogy. The EMC proposition (it’s in the mail to us shareholders it says) reminds me of the way the Boston Celtics let parquet lovers with nothing better to do with their hard-earned (or even inherited) cash buy a piece of “the Green,” also about 10 years ago: Ownership—with no control—of a dying “franchise.”

Let’s forget the corporate governance issues outlined in last week’s EMC SEC filing. The deal is something along the lines of investors can buy 10% of VMware, but the investment community’s aggregate share will only be 1% of voting rights because EMC retains a non-public class of shares. And its auditors say VMware has weak internal accounting controls, kind of odd for an almost 10-year-old firm owned outright now for three years by a multi-billion-dollar 28-year-old public company.

The real issue is that virtualization as a separate function may have run its course. Red Hat (RHAT) bundled it into the recent version of its Red Hat Enterprise Linux [RHEL] and Microsoft (MSFT) plans to bundle it into the upcoming server operating software replacing Windows 2003. That’s what Microsoft’s acquisition of Softricity in May 2006 was all about. The Red Hat/Microsoft one-two punch at the low end of the market means today’s separate market for virtualization software may be at its peak right now (at about .3% of total software spend). It’s kind of the spell checker of our time. Here’s the kiss of death: there’s already a standards group for the idea.

Don’t get me wrong. I understand the concept. Working on Multics marketing in the early 1970s, I was there at the beginnings of virtualization that EMC talks about in its SEC filing as if it was ancient history (I guess it is). It goes like this:

Let’s do for the 25 million x86 servers out there what Multics, VMS, and AOS/VS did for GCOS, VAX, and Eclipse in the 1970s. Admittedly, VMware’s strength is that it can virtualize multiple operating software brands and the earlier products virtualized only their developers’ own operating software. But given the 30-year-plus maturity of this concept and its inevitable commoditization, the barrier to market entry by competitors is low. VMware says as much in its filing.

While server virtualization makes sense, I don’t understand why I would want to virtualize my desktop PC and laptop? According to IDC (according to EMC), less than 1% of non-server personal computer devices are virtualized. I am surprised it’s that high. Presumably it’s because I need to mix some Linux desktop applications in with my Windows apps? Or turn my desktop into a server?VMware does have some good associated systems and lifecycle management software but Microsoft, Red Hat, BMC (BMC), and so forth will add that capability to their related products just as fast as virtualization reaches commodity status in the mainline operating systems.

Come on, EMC, spin it out or not. If there’s hidden value in VMware, give us our dividend quickly for our patience the last three or four years. I don’t think the value is going to be there very long.

EMC 1-yr chart:

Comments

[cameronm]

Virtualizing the server is about CPU utilization - saving money and gaining service flexibility in your data center. Desktop virtualization is about security and privacy. In the fullness of time virtualization of desktops could be a far larger business than on the server.

There are two scenarios for virtualizing the desktop. The first is for software developers and testers and this was of course the first segment VMware addressed and how they made their first $100M of revenue. This however is a market niche of limited size and well penetrated today. The second reason is security and this is a huge potential market. Today of course there are billions of dollars spent to secure personal computers from viruses, spyware, malware and phishing by the likes of Symantec and McAfee and many others, and many would argue they do a fairly miserable job of it. Virtual machines offer a very powerful solution to this problem by isolating different activities (like say browsing the web, or playing that multi-user video game,r even leaving the corprate firewall) in a separate virtual machine that is destroyed at the end of the users session. In effect, who cares if you pick up viruses and spyware when at the end of your session you just destroy the virtual machine taking the viruses and spyware with it. It is a super powerful and elegant solution to one of the most persistent problems plaguing PCs today. In this sense you could imagine why almost 100% of all PCs in the future could come with virtual machine technology. There is a private company called Green Border that is trying to do this today and Microsoft is rumored to be taking steps towards this approach with IE.

Cam

[DennisByron(Research2.0)]

Cam -

OK. If I buy into your scenario, then I still feel the same way as I feel about server virtualization--no separate market for VMware to compete in. I think you agree when you say Microsoft is taking steps toward this approach.

But I also don't buy into the scenario that virtualization is a marketable way to make PCs more secure; too powerful and too elegant in my opinion.

Then there is the $64,000 question for about 5 years out: what is a PC any ways? The examples you give will all be happening in the cloud and the cloud will worry about security. For the personal devices where I (or my boss) cares about security, physical means will predominate because any software-enabled methodology can be software hacked.

[hotta fire]

I'd like to point out that Microsoft's virtualization package isn't expected to support any operating system other than Windows.

I use vmware on my laptop to concurrently run Ubuntu and Windows. Most people wouldn't do it, I admit, but that is where your personal computer usage comes from.

Oh, and vmware is currently heavily pirated if any of you didn't already realize as much.

As you may be able to discern from my comments I have no opinion about whether vmware will succeed as an independent company. I think the product is solid and the market is much bigger than your think but I counter that with the knowledge that MSFT is embracing virtualization and there are other people out there competing with vmware for the Mac market.