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VMware, Inc.: Hot IPO But Beware the Risks

Interested in trying to get in on the VMware IPO?  Yup, same here.  All of us who love this virtualization stuff knows that VMware is the king of server virtualization right now.  I don't know too many people who would dispute that... But I read this article at SeekingAlpha that says a lot and adds a certain perspective to the whole IPO thing.  They write:

... 

Now, EMC is going to sell about 10% of VMware, or just under 38M shares, to the public at $23 to $25 a share. The reason there is so much buzz around this IPO is that VMware has been growing by leaps and bounds and the investing public would love to have a piece of this growth story. An added vote of confidence comes from Intel who is spending over $200M to purchase 9.5M shares.

VMware had record sales in 2006, growing revenues 83% during the year to $709 million. It finished the fourth quarter of 2006 with year-over-year revenue growth of 101%, delivering accelerating year-over-year growth for the fifth consecutive quarter and putting it on track to become the fastest software company ever to reach $1B in annual sales. In the last quarter, VMware's sales doubled to $258.7M yielding a profit of $41.1M, an increase of 15.9% over the year before.

Why is the company so hot? VMware's virtualization software lets multiple instances of operating systems run simultaneously on the same x86 computer, which in turn lets computers be used more efficiently and, in a grander vision, be consolidated into pools of processing power constantly adjusting to changing workload demands. This ability to host multiple functions or users on a single server provides huge cost saving, flexibility and simplification benefits for the corporations that are deploying VMware software. This is what has driven the acceptance of the company's products in the IT marketplace.

I was pretty excited myself about being able to own a few shares but in reading about the upcoming IPO, I came across some sobering news. There are three issues that the average investor will need to consider before putting in that buy order.

1. The small number of shares being offered to the public, only 10%. The offering will be over-subscribed and the individual investor will only be getting access to shares after the big pop that can be expected when the big underwriters and funds finally begin to sell on the open market.

2. Revenues have been increasing rapidly but expenses are increasing as fast as revenues. Will this eventually hold the stock back when it becomes publicly traded?

3. The competitive landscape is becoming more complicated. VMware pretty much had the field to itself but there are now a couple of initiatives that are having an impact. There are open-source solutions beginning to emerge for the Linux world. More ominously, Microsoft has developed a virtualization solution that they will be bundling with their Windows server software. That essentially means that buyers will receive it (almost) free as part of their basic operating system purchase. There will be some companies that will take the Microsoft product as the path of least resistance and not even consider VMware.

VMware is still a strong company riding a wave of popularity in a market segment that is attractive to large and small IT organizations. After all, all CIOs want to save money and the larger IT organizations will most likely stick with VMware. The individual investor, though, will not get this stock cheaply. EMC will be the prime beneficiary. They will receive the returns of the IPO itself and they will also continue to own 90% of a company that may end up being worth $20B in total if you extrapolate the value of the 10% that is trading publicly. This is not to say that individual investors should turn their backs on VMware but it may be wise to avoid buying too early. Let the stock pop as expected and then return to more reasonable levels as IPOs tend to do. Only then consider purchasing shares after a careful analysis of the pros and cons.

Read the entire original article, here.

Published Thursday, July 19, 2007 5:20 PM by David Marshall
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Comments
andreamorris - (Author's Link) - July 20, 2007 11:14 AM

Hi David, Thanks for the link to this. IPOs are always risky - the more info I can read before I buy, the better.

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