VMware Stock Needs a Successful Pivot in 2020
Many investors were looking at 2020 as being the start of something big for VMware (NYSE:VMW). After a year spent on acquisitions, the company appears ready to start making its transition to a hybrid cloud provider.
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That would be welcome news to investors who are watching a stock that has dropped 25% from its 52-week high set in May 2019. But so far, 2020 has brought a lack of clear direction. Instead of participating in the market melt up like other tech stocks, VMW shares are down about 5% since the start of the year. And much to the chagrin of some traders, the stock is struggling to push above a support level at $150.
Acquire or Die
As the cloud revolution was taking place, VMware quickly realized that its position as an old-guard enterprise company was under attack. Companies are moving away from traditional virtualization and looking to containers to hold their apps, configurations and settings.
This transition played out in the price of VMW stock. While companies like Microsoft (NASDAQ:MSFT) were having a banner year, VMW stock had a gain of just over 10%. Smartly, VMware went on a buying spree.
One of the key phrases in the hybrid cloud model being adopted by VMware is “open source technology.” IBM (NYSE:IBM) became the undisputed leader in open source container applications with its expensive $34 billion purchase of Red Hat in 2019. This gave IBM access to Red Hat’s OpenShift Kubernetes platform. VMware’s response is a $2.7 billion purchase of Pivotal Software. This is a move that VMware CEO Patrick Gelsinger said gives the company better assets for far less cost.
The acquisition of Pivotal is at the core of VMware’s own Kubernetes strategy called VMware Tanzu. This portfolio of products and services will give customers the option to build and deploy applications on Kubernetes using different development platforms.
But that wasn’t the extent of VMware’s acquisitions. The company also acquired Bitnami with its packaged application catalog and Heptio for deep Kubernetes expertise. All this in addition to VMware’s $2.1 purchase of Carbon Black.
VMware Has to Deliver
To be fair, VMware had to make these acquisitions. And compared to IBM’s purchase of Red Hat, it may turn out to be a savvy and fiscally sound investment.
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But now, VMware has to deliver. To that end, VMware’s goal is to get its existing 600,000 vSphere customer base to adopt container technology in addition to VMware’s vSphere virtualization platform. The initiative, called Project Pacific, unites vSphere with Kubernetes.
Analysts and Investment Firms Believe in the Business Model
Of the 24 analysts that have given a rating on VMware, 15 have given a buy rating while eight others gave it a hold. The global investment firm Oppenheimer recently reiterated its “outperform” rating on VMware and maintained its price target of $200. “We see a compelling risk/reward scenario as we don’t believe recent strategic initiatives and model evolution has been factored into shares,” said Oppenheimer in a note to investors.
Analysts are projecting an earnings per share for 2020 and 2021 that suggests modest, but certainly not spectacular, profitability growth. Some of that may be that analysts are not yet factoring in the potential growth from the Pivotal acquisition.
It’s Too Early to Tell What 2020 Holds for VMW Stock
Although VMW stock is off to a rough start, it may represent a buying opportunity. My InvestorPlace colleague, Vince Martin, made a case that a price just below $150 might be an attractive buying point for VMware. Martin points out the company’s large free cash flow as a benefit regardless of how successfully it can make the pivot in its cloud strategy.
However, that alone will not be enough to excite investors. For that to happen, the company will have to show growth. And that is something that won’t be clear for a couple of quarters. Which means the stock will probably be stuck in neutral. And as Will Healy wrote, VMware is majority owned by Dell. Now that Dell shares are trading again, the company may decide to buy VMware outright or spin off the company.
Risk-tolerant investors may see more reasons to jump in. But right now, I see better, alternative opportunities in this space.
As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.