VMWare: Missed Opportunity For EMC?

Over the weekend Diane Greene and VMWare were featured in a profile peice in The Economist which praised both the company and its CEO. EMC acquired VMWare for $650M, and then within a few years had split VMWare out on its own by floating 10% of the company. It was the biggest and most exciting tech IPO since Google, and analysts lavished the company with praise while institutions piled in driving the stock higher. At the end of October in 07, only a month after the inital IPO, there was so much attention on VMWare that the stock rose to $124 – a market cap of $46B, which also drove up EMC to a market cap of over $55B.

Fast forwrd a year later, and today market darling has lost a quarter of its market cap and had its founding CEO, Diane Greene, forced out by the board, after yet another growth expectation downgrade. The initial VMWare growth expectation for 2008 was 90%, with a revenue target of $2.5B. This was first downgraded to 80% in January, and then further to 60% after the company reported its first quarter. With second quarter results only a week away, expectations have been lowered again and some forecasts now predict a 2008 year of as low as $1.7B, or even lower – which would present a year-on-year growth rate of just over 30%, far lower than initial expectations.

We have heard rumors today, and there are also some previous references on other blogs, that EMC were attempting to sell all or part of VMWare during the previous 6 months and leading up to the end of Q2. EMC were anticipating that a crunch day would eventually come where the market would punish the stock for not matching expectations, and it would be difficult to regain market and mind share as Microsoft entered the market with their own virtualization product. We hear that the potential suitor was Intel, and also potentially either HP or Oracle (although that is much more speculative). A full acquisition may have been unlikely because of short-term capital gains tax implications, but it isn’t difficult to imagine Intel acquiring VMWare as a short but big step into the new growing market.

VMWare built the virtualization market and were all alone in a growing industry that was changing the way datacenters are run and managed. Executive and research reports run thick with terms such as ‘dynamic datacenters’ but in essence what virtualization allows is a dynamic shift in how hardware, operating systems and applications are managed on a large scale. Through virtualization servers are added, removed and manged through control panels rather than through physical processes – and the cost savings and increased efficiencies are what have been driving sales of VMWare products. VMWare had total ownership of the new market, and their IPO and valuation reflected that, until it was disrupted by the entry of Sun, Citrix, Oracle and now finally Microsoft.

David Lynch is the VP of Marketing at Embotics, a provider of a virtualization management product and tools and a partner with both VMWare and Microsoft. He says that “the changes at the top of the company were bound to happen at some point, as they are now in a new phase” he adds “Microsoft entering a market dictates the next level of growth and what is required [from the incumbants]”. As a vendor in the virtualization market, Embotics has watched as VMWare steadily built up a customer base of some 25,000 clients – while Microsoft has been able to shortcut that process with their existing server install base which is orders of magnitude larger. It would be impossible for VMWare to prevent Microsoft from capturing market share, and they have done well to survive as far as they did as in previous examples, such as with PKI, even an announcement of an impending new Microsoft product has been enough to freeze a market and kill competitors.

Lynch goes on to say that he belives that the greatest flaw in the recent VMWare strategy was in attempting to take Microsoft on head-to-head, by not responding when Microsoft reached out in an effort to standardize virtualization container formats. He referred to this move as “foolish”, as in a head-to-head showdown there is only a single winner, and it is usually Microsoft. Lynch believes that the new President and CEO of VMWare, Paul Maritz, is more suited to the next phase of development as he is an experienced former Microsoft executive and understands the challenges that VMWare are about to face directly.

With the combination of a slowdown in growth and the entry of formidable competition, VMWare may have already passed its peak – unless a new team can adapt the company and its strategy. The right strategy would be for the company to accept Microsoft and other vendors as part of a new hetrogeneous virtualization environment, and rather than attempting to own the whole market focus on its key capabilities as a technology and services provider within particular areas.

Because VMWare makes up such a large part of the value of EMC, the problems that VMWare are facing are also big problems for EMC. In attempting to sell all or part of VMWare EMC likely recognized that they only had a short time window in which to realize their gains before the next phase of the virtualization market would take hold with much larger and more formidable competition. VMWare has yet to prove that it can compete head-to-head, and with a lot of new technology research and marketing money being poured into the market by larger competitors, it can quickly lose its edge. VMWare must adapt, or what was only yesterday the fourth largest software company in the world could easily end up as a footnote in IT history just as many companies before it who established new markets to then only lose them very quickly.