January 23, 2009 - 7:05pm EST by
2009 2010
Price: 11.16 EPS $0.84 $0.84
Shares Out. (in M): 2,041 P/E 13.3x 13.4x
Market Cap (in $M): 23 P/FCF 8.2x 8.5x
Net Debt (in $M): -2,415 EBIT 2,117 2,084
TEV ($): 20 TEV/EBIT 9.6x 9.7x

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EMC Corp. Notes

 SUMMARY RECOMMENDATION: EMC is a leader in the enterprise storage and security business. The industry has strong secular tailwinds with the explosive growth of data digitization and need for storage and security. EMC has a very solid balance sheet and is trading at all-time low valuations. An entry point at around $10.50-$11.00 offers 3:1 upside to downside -> downside is c.$9.00, assuming a much greater decline than company's guidance; upside is $15-$18, assuming company meets expectations.  A spin-off of VMWare or Shareholder Activism could provide a value-unlocking catalyst.

 Company Description:

 EMC is a leading provider of hardware, software, and services for enterprise network storage. Historically focused on proprietary storage hardware, the company has recently increased its focus on its software and services segments, which now account for more than 50% of revenue. EMC also owns approximately 85% of VMware, a leading provider of virtualization software The company sells its products and services through agreements with distributors, system integrators, resellers, and original equipment manufacturers in the United States, Europe, the Middle East, Africa, the Asia Pacific, Latin America, Mexico, and Canada (40% of revenues are international). EMC Corporation was founded in 1979 and is headquartered in Hopkinton, Massachusetts.

 Business Segments / Products

 The company has 4 business segments:

  • Information Storage segment (77% of revenues) offers networked information storage systems, networked attached storage, content addressed storage, or direct attached storage environment. It also offers software, which control and enable replication, storage, protection optimization, and data movement of information.
  • Content Management and Archiving segment (5% of revenues) offers software, which helps customers optimize business processes, as well as create, manage, deliver, and archive information from documents and discussions, e-mail, Web pages, images, XML, reports, records, rich media, etc.
  • RSA Information Security segment (5% of revenues) offers security product and services, such as enterprise identity and access management products, consumer identity and fraud protection solutions, encryption and key management software.
  • VMware Virtual Infrastructure segment (13% of revenues) offers virtual infrastructure solutions and services that enable customers to run multiple operating systems simultaneously on the same physical machine. Its automation products automate system infrastructure services, such as resource management, availability, mobility, and security to reduce operational complexity.

 The Bull Case

  • Strong Secular Industry Tailwinds behind EMC's Markets and Products:
  • As businesses continue to digitize everything from correspondence to confidential customer information, management and storage of the underlying data has become an important process.
  • IDC projects enterprise storage growth to average more than 50% through 2012, though spending growth will be lower as the cost per unit of storage falls.
  • Virtualization is fueling demand for centralized storage that can be shared by a pool of servers or desktops. As these factors drive capacity expansion, demand rises for greater performance and energy management.
  • Cheaper and faster memory components lead to lower-cost/higher efficiency storage systems.
  • EMC - Strongly Positioned to Take advantage of Growing Demand:
  • EMC is the leading enterprise storage provider with 25% market share
  • Large scale provides a competitive advantage- > EMC's $1.5bn R&D spending is unmatched in the industry. Expansive product offering.
  • Switching costs and large installed base provide additional competitive advantages. Companies prefer to standardize the equipment in their data centers, simplifying training and support as well as leverage their existing software and only pay for additional hardware.
  • Ownership of VMware gives them a "leg up" in virtualization storage industry growth
  • Relative Recession Resilience within IT Hardware sector
  • See discussion below
  • Strong Historical Growth
  • EMC has grown Sales and EPS at 20% and 50% CAGR over the last five years.
  • EMC has not missed EPS expectations in the last 16 quarters.
  • Strong Balance Sheet, Solid Free Cashflow Share Buyback
  • $3.7bn of net cash ($1.80 / share), $1.5-$2.bn of FCF and a $1bn worth of share buyback
  • VMWare "Option" / Catalyst
  • VMWare is trading a fraction of its IPO price from last summer. Given VMWare's different growth option and still higher valuation, a spinoff of VMWare will unlock value as EMC trading a discount to NAV.
  • Cheap Valuation
  • See discussion below

The Bear Case

  • IT Hardware More Susceptible to Economic Downfall than Software:
  • Storage and Security is a critical business process with high ROI, generally has performed better than other hardware products
  • EMC has grown its software offering, currently accounting for 50% of revenues
  • Competitive Landscape - Pricing pressures:
  • EMC has made a number of acquisitions to address market niches occupied by innovative startups
  • Aggressive pricing for enterprise storage systems - however EMC prices its products at or below market
  • Decelerating Growth:
  • EMC's growth has decelerated recently as its market share has grown. Its products represent 25% of market and there is benefits to scale as outlined above
  • Opportunities to expand in Small/Medium-size Business segment
  • IOMEGA acquisition - consumer sector growth opportunities
  • Hardware is Becoming more Commoditized:
  • As per above, EMC has made a push towards software
  • Customer Concentration
  • Dell accounts for 10+% of sales - agreement ends 2011 (Dell has made an acquisition of a company that focuses on SMB enterprise storage, Company claims it does not jeopardize relationship with Dell)
  • Limited Operating Leverage
  • Despite EMC's revenue growth in mid-teens and large scale, Gross and EBITDA margins have stayed flatish in last 3 years.
  • Rise in Deferred Revenues
  • With the increase of EMC's software licensing revenues, its deferred revenues have increased as well.
  • Deferred revenue include a subjective fair value estimates for maintenance and pricing of software sales. Any pricing pressure during a downturn could lead to write-downs of such revenues

Is EMC Recession Resilient?

  • What happened in 2001-2002 Recession:
  • After growing revenues at 20-30+% during the 1990s, EMC's top line declined 20% both in 2001 and 2002. Gross margins went from 47-52% range to 40+/-%. Net income margins declined from mid-teens to 1-2% during the recession
  • Several reasons for the decline 1) EMC's customers included a number of internet companies; 2) Storage utilization was low 20-25%, hence customers postponed adding to capacity; 3) EMC was a primarily a hardware company; 4) EMC priced its products at 50-60% premium to market and faced aggressive pricing competition in downturn; 5) Technology was in the "eye of the storm" during the previous recession
  • How is the company positioned in 2008/2009:
  • EMC's management feels they are in much better situation now: 1) EMC's product and client base is much more diversified, including software products; 2) EMC's pricing is at or below market; 3) Storage and security are mission critical, less curtailment than other hardware products; 4) Virtualization provides cost savings opportunities -> helpful in cost-cutting, recessionary environment (high ROI); 5) Utilizations is 40-50% (maximum is 65% for optimal operation) so less available capacity to delay additional purchases.
  • On the last call, the CEO emphasized that the company has learned its lesson from the last severe downturn in 2001/2002 and has positioned itself much better for a potential downturn


  • DOWNSIDE Scenario
  • On latest conference call, CEO suggested that their best estimate is that IT industry grows minimally 1-3% in 2009, and that their segment does slightly better, perhaps high end of range. He also expects margins to stay constant.
  • Our DOWNSIDE scenario, assumes revenues are down 10%, half as bad as in last recession, and gross margins decline 10% to 50% with Net Income margins halfed to 6%. This DOWNSIDE analysis affects only the core EMC and not the VMware financials.
  • The following table summarizes the DOWNSIDE Scenario.

Core EMC DOWNSIDE Valuation            
2008 Core Sales $12,956 (9-months actual, 3-month company guidance)    
  Expected 2009 Change -10% (worst decline was 20% in 2001, 2002, company expecting 3% growth)
2009 Core Sales $11,660              
  Expected '09 NI Margin 6% (Current NI Margin 11%, reflecting a 5% decline in gross margins)  
Net Income  $699.62              
Shares Outstanding 2070              
EPS   $0.34              
Assumed P / E 15.0 (historically EMC's trough P/E was 17x)      
Value of Core EMC $5.07              
Core EMC Cash / Share $1.21              
Assumed Low for VMW $17.00 (VMW traded as high as $125 in late 2007, all -time low was $20)  
Value of VMW / EMC $2.72 (each share of EMC "owns" 0.16 shares of VMW)    
Total DOWNSIDE EMC $9.00              

 o Assuming consensus is reached for EMC, the following conservative analysis highlights the UPSIDE.

EPS   $0.70 (current consensus estimates for core EMC)
Assumed P / E 15.0 (historically EMC's trough P/E was 17x)  
Value of Core EMC $10.50          
Core EMC Cash / Share $1.21          
Assumed Low for VMW $25.00 (a premium to VMW's current price)    
Value of VMW / EMC $4.00          
Total UPSIDE EMC $15.71   $17.50 If VMW at $35  


An Attractive Hedging Strategy

 LONG 1 Share of EMC -> $11.16                             LONG 1 Jul' 09 $11.00 Put - > $1.46

                                                                           SHORT 1 Apr'09 $9.00 Put -> $0.70

                                                                           SHORT 1 Apr' 09 $8.00 Put -> $0.47

                                                                               (or short 2 $9.00 puts)

 EMC stock price's all-time low of stock was in 2002 - $5.10, however it touched briefly $8.40 in October 2008, the stock has not fallen below $10 for the last 5 years, other than for briefly in October 2008.

 The strategy provides an almost COSTLESS protection ($0.29) on the downside through our worst case price of $9.00. You own the shares at a price below $8.00.




Spin-off of VMWare; Shareholder Activism.

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