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VMWare IPO shows virtualization market is emerging as a reality

Quoting MercuryNews

An initial public offering later this summer will highlight a transforming technology - virtualization - expected to become a $20 billion industry in a few years.

Virtualization software, among several uses, can make one computer function as if it were several. As a result, corporations are getting one file server to do the work of about five, on average, which cuts capital, labor and real estate costs at data centers. The energy savings alone can pay for the cost of the program in a year.

EMC Corp., of Hopkinton, Mass., is tapping into the increased interest in virtualization by spinning off 10 percent of its VMWare unit, by far the largest maker of the software. According to Sanford Bernstein analyst Toni Sacconaghi, VMWare has a market share of about 85 percent.

"This year is the inflection point. We see close to total saturation of the server market in about three years," said Rachel Chalmers, a senior analyst with the 451 Group, a research firm in San Francisco.

About $1 billion worth of virtualization licenses were sold for file servers last year, according to technology industry research firm IDC in Massachusetts. That number looks to grow to about $3.1 billion by 2010, estimates IDC analyst John Humphries.

"Some of the technology has been around for years. What's new is server virtualization, and how it's being used not just for consolidation but for disaster recovery and higher availability," Humphries said.

While IDC's growth estimate for virtualization would hearten many industries, Chalmers finds it "really conservative." IDC expects that 15 percent of servers sold in 2010 will be virtualized - but Chalmers expects most all of them will be. Also, she foresees virtualization software being bought for some of the 25 million servers already in existence.

"The economics make this too expensive not to do," Chalmers said.

There are limits, she said. The technology is being applied to the most common class of servers, known as "x86," rather than to mainframes; the x86 covers about 80 percent of the market, based on volume. Also, the biggest x86 data centers, like those owned by Google Inc., won't benefit much from consolidation because they already optimize their servers.

But virtualization has uses other than consolidating file servers and improving the performance of data centers. Companies have started applying the technology to desktop computers, for example. Sacconaghi estimates that by 2010, the desktop license market could grow to $900 million.

Analysts expect that virtualization could be applied to other parts of technology, like storage systems and network hardware. However, such applications are still in development, and estimating the size of these secondary markets is difficult.

Makers of virtualization programs lock in annual revenue on top of one-time license fees by selling maintenance and support contracts to almost all business customers. As for other software businesses, every $1 billion in licenses generates a highly profitable contracted revenue stream of about $200 million for maintenance. By 2012, maintenance revenue could exceed license revenue.

The biggest virtualization market, however, may be in consulting and management services. IDC estimates that the virtualization services market will grow to $11.7 billion in 2011 from $5.5 billion last year, as the technology becomes much more mainstream.

On Tuesday, EMC said VMWare grew sales 89 percent year-over-year to $298 million in the second quarter. The list price for VMWare's premium server product is $5,750. Its actual revenue typically is two-thirds of its list price, after discounts, reseller commissions and deferred revenue.

Makers of virtualization software, although they don't generally pursue the consulting services market, are getting the most interest from investors. Two weeks ago, Santa Clara-based Intel Corp. moved ahead of the highly anticipated VMWare public offering and agreed to acquire about 2.5 percent of the company for $219 million, or $23 a share. That values VMWare at almost $9 billion, compared with the $635 million EMC paid for it in early 2004. Sacconaghi figures VMWare is worth about $14 billion, or around $38 a share.

On July 9, underwriters set VMWare's pending IPO at 33 million Class A common shares at an estimated price of $23 to $25 apiece. Following the IPO, VMWare will have two classes of stock, Class A and Class B.

Naturally, the growth of the market has attracted competition, such as Redmond, Wash.-based Microsoft Corp. The software giant postponed the public beta version of its main product to rival VMWare to the second half of this year from the first and withdrew some expected features, but it could catch up to VMWare in a few years, analysts agree.

For the businesses of smaller companies, VMWare faces rising competition from privately owned Palo Alto-based XenSource Inc., which has Linux-based products that cost much less to install than VMWare products. Several startups, such as Lowell Mass.-based Virtual Iron Software Inc., also will compete.

Due to IPO regulations, neither EMC nor VMWare were able to comment for this article.

Read or comment on the original, here.

Published Saturday, July 28, 2007 10:12 AM by David Marshall
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