<p>VMware (NYSE: VMW) is a very profitable and inexpensive cloud storage that has taken a value worth buying. The company reported its annual financial income up to and including 31 January. It shows that VMware makes big margins in its cloud software subscription, licensing and serving.
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However, the company, 80.7% owned by Dell (NYSE: DELL), which also controls 97.5% of its voting rights, faces competition issues.
VMware stock has problems
Barron recently published an interesting report on VMware’s competition from a technology called Kubernetes.
The crux of the article is that more companies are migrating their data and business to the cloud faster than ever. This is bad news for much of VMWare’s older software, apart from its recent acquisition of a cloud company Pivotal.
In other words, the transition to the cloud goes faster and VMware can lose business. At least that’s what the market is worried about.
VMWare does pretty nicely, thank you
The company provided a forecast for its revenue and cash flow, which although lower than analysts’ expectations, is still extremely profitable. Barrons reported market disappointment over the figures and VMware’s apparent deficit.
For example, the company reported Q4 adjusted earnings per share of $ 2.05 compared to the Wall Street consensus estimate of $ 2.17, according to FactSet.
But all was not so bad. VMware had sales of $ 3.07 billion for the same quarter, an increase of 11% over the previous year. But this was above the average analyst estimate of $ 2.95 billion.
But let’s keep things in perspective. Free cash flow for the fourth quarter was $ 1.02 billion. This is a huge margin compared to its revenue. Free cash flow represented a third of quarterly revenue. It’s huge.
In addition, free cash flow margins were even higher for the year ended 31 January. VMware generated $ 3.59 billion in free cash flow. This equates to a margin of 35.8% on its annual revenue of $ 10.81 billion.
Very few companies can convert so much of their revenue into free cash flow. In addition, the future prospects are not so bad.
Outlook is not as gloomy as some say
The truth is that VMware will generate good profits for a good while, even if cloud migration continues faster as its older revenue fades.
For example, the company estimated that the coming fiscal year would lead to $ 3.76 billion in free cash flow. It still represents a margin of 31% on its expected revenue of $ 12.05 billion this year. And revenue will increase by at least 11%, according to the company.
How can the company be so sure of its prospects? One reason is the enormous amount of “revenue” it has in its backlog.
For example, VMware reported that it had $ 9.268 billion in non-revenue revenue. The companies called this “deferred” revenue. In addition, it has $ 4.05 billion in long-term revenue.
The total revenue earned of $ 13.3 billion represents contracts that customers have signed but the revenue has not yet been earned or invoiced. In fact, it is a hidden asset.
Yes, many software companies have these assets. Sometimes companies can terminate these contracts. But VMware’s acquisition of Pivotal and Carbon Black, both operating in the cloud migration space, will help the company retain these customers.
What analysts say about VMware Stock
Deutsche Bank lowered its price target to $ 165 from $ 190 after the result. Right now, the VMware stock is at $ 120.52, so that equates to an increase of only 37% instead of 58%. But the point is that the analyst thinks the stock is worth a lot less now.
By the way, if they are correct, this is not good news for the Dell stock, as it represents a large part of its total value. Seeking Alpha analyst Thomas Lott published an interesting article in December about VMWare as part of its sum of parts valuation.
What should investors do with VMware shares?
Right now, the VMware stock is trading at an implied free cash flow of 7.5%. It is derived by taking the expected $ 3.76 billion in free cash flow this year divided by its market value of $ 50 billion today.
Other technical stocks such as ServiceNow (NYSE: NOW) are much more expensive. The FCF return is 1.6%. Another competitor Arista Networks (NYSE: ANET) has a more expensive 6.4% FCF return over the past 12 months (LTM).
In addition, Citrix Systems (NASDAQ: CTXS) has a 5.7% FCF return. In fact, another competitor Nutanix (NASDAQ: NTNX) has a negative FCF return.
But bigger buddies are much cheaper based on this. Cisco (NASDAQ: CSCO) is cheaper than VMware with 8.7% FCF return. IBM (NYSE: IBM) has a 10.8% FCF return.
So the bottom line is that the VMware stock is cheap, but not as much as some of its peers. Given the analyst’s disappointment with the stock with the latest results, it is possible that the WMware stock may fall further.
However, investors should keep in mind that this is still a very profitable $ 50 billion market value company. It provides a large amount of free cash flow every year. In addition, it has a large stock of unearned revenue. It will not go away, despite what some writers and analysts may make you believe.
At the time of writing, Mark Hake, CFA holds no position in any of the above securities. Mark Hake runs the Total Yield Value Guide which you can review here. The guide focuses on high total return values. Subscribers get a free trial period of two weeks.