VMware Is the 'Crown Jewel' in the Historic Dell-EMC Deal

Dell's agreement to acquire EMC for $67 billion, which was announced this week, is by far the largest IT industry deal ever and Dell is poised to have the most comprehensive portfolios of server, storage and IT enterprise management software and services. The deal nevertheless was not welcome by VMware shareholders, who have hammered the stock in the days since the deal was reached.

A day after Dell Founder, Chairman and CEO Michael Dell and EMC Chairman and CEO Joe Tucci talked up the "synergies" and potential cost savings of the deal that will ultimately generate $1 billion in increased growth in its datacenter business, VMware's CEO Pat Gelsinger told CNBC why he feels the market's fears are overblown.

"To us the deal is about growth and having Dell and EMC come together in a larger entity accelerating growth of VMware, we think is a huge opportunity for us in the mid and long term," Gelsinger said. "As you move past this period of volatility, the growth starts to become very apparent from the marketplace. We believe ultimately it will be a very good thing for the market, for VMware for our employees and customers."

While the two companies become a larger provider of IT solutions, Gelsinger said VMware is at the epicenter that will drive that potential growth. "VMware being the crown jewel of the family is about seeing that growth potential," he said.

Given that most large mergers rarely live up to their potential and a good number are outright failures, Dell's largest competitor Hewlett Packard Co. has the most to gain or lose. In a widely reported letter to employees HP CEO Meg Whitman said Dell shareholders "will have to pay roughly $2.5 billion in interest alone." Perhaps that's sour grapes for Whitman, who a year ago was rumored to be courting a deal with EMC. Instead, breaking itself into two companies, which will become official Nov. 1.

"If this goes through HP is totally hosed," wrote independent IT industry analyst Rob Enderle. "Dell would appear as a far more complete vendor than HP is and with HP's crippling layoffs its customers will quickly be looking for enterprise-class alternatives. With EMC Dell could aggressively go after that business hitting HP before the firm can stabilize and protect its client base."

While Enderle believes the Dell-EMC deal can succeed, independent analyst Charles King of Pund-IT, believes the main issue is that the new entity will create a new, non-voting class of VMware shares (worth 0.111 of EMC's 81% stake in the company), which will devalue/destabilize the common shares. Investors are also are concerned that the owners of the new shares (particularly large institutional investors like Elliott Management, which has been agitating for EMC to sell off its VMware stake to create a sizable one time dividend), will sell off the tracking shares as soon as the deal is finalized, he noted.

"There's also some disappointment that VMware wasn't spun off entirely, mixed in with concerns about Dell's ability to effectively manage the company," King said. "Frankly, this scenario was never likely given the value that VMware has provided EMC over the past decade."

Patrick Moorhead, an independent IT industry analyst with Moor Insights & Strategy, who was interviewed separately by CNBC, said not to overlook the combination of two large hardware companies with largely complementary product lines could offer greater scale.

"There's a hedge strategy which says you go with the curve and develop scale and that's what I believe is happening here," Moorhead said. "What this will do is create the largest, by scale, hardware company that's out there. That's the play that Dell is making here."

Asked if he believes Dell will be forced to issue more stock or spin off businesses such as the popular SecureWorks unit, Moorhead pointed to the fact that Dell has benefitted from the historically low interest rates. Since going to the bond markets two years ago to finance its deal to go private, Dell's debt has risen from junk to investor grade, he noted.

"What that says is they're able to pay down that debt," Moorhead said. "I believe that gave the confidence for this to be primarily a debt deal. If they had to spin off VMware or something like SecureWorks to generate that cash at an even greater clip, they do have that option.  But I don't necessarily think that's Plan A  for them. I think that would be more along a Plan B."

Posted by Jeffrey Schwartz on 10/14/2015 at 1:03 PM