EMC, with Elliott Management at the door, braces for a showdown

EMC(s emc) remains the leader in traditional storage systems and has made credible forays into the new-era flash-based systems as well. But nearly a quarter ($5.1 billion) of EMC’s $23.2 billion in revenue last year came from VMware(s vmw), the crown-jewel of a  federation of companies put together by EMC’s CEO Joe Tucci.
The purported impetus of the $1 billion stake Elliott Management took in EMC  — first disclosed by the Wall Street Journal  (registration required) — is to wring more value out of the company by prying apart that federation, a plan of action that Tucci will undoubtedly fight. But while EMC, which would not comment,  is apparently not thrilled by this unwanted attention, Wall Street apparently liked what it heard about Elliott’s alleged plan which could result in EMC selling its 80 percent stake in VMware(s vmw) and/or its 62 percent stake in Pivotal. EMC shares closed up 5 percent to $28.33 on Monday.
There’s also the possibility that hardware rivals — Cisco(s csco), HP(s hpq), Dell — all of which are building their own storage businesses — would snap up EMC itself post-breakup. EMC’s problem is that its stock is seen as a chronic underperformer, hovering in the low mid-twenty-dollar range for the past year.
EMC Price Chart

EMC Price data by YCharts

Taking on the federation

Critics say EMC’s shares are held hostage by a corporate family bond that forces EMC and VMware to work at semi-arms length. Without that tie, EMC might have gone whole hog into software-defined storage earlier and would not be trading at a fraction of the multiple of NetApp, is their argument. And VMware would be free to pursue its software-defined data center vision without worrying about offending its parent company, which — after all — is a hardware company.
Last year, Chris Wolf, who was then a Gartner analyst covering the company (and is now a VMware CTO) told me that VMware’s ties to EMC have been holding it back.
He said:

“So far, the software-defined data center is still positioned as requiring enterprise-grade hardware. That’s not how Amazon, Google, and others do it. Look to the public cloud and the major providers are building stacks where nearly all of the value is abstracted from software. For VMware to offer cost competitive solutions comparable to the public cloud, it will have to show customers how they can build data centers where nearly all value is in software. When you place a premium on hardware and software in your architecture, you will never keep up with the public cloud from a pricing perspective.”

With Elliott pushing a breakup agenda, things might actually change. In a research note, UBS Analyst Steven Milunovich wrote:

Elliott got NetApp to return more cash to investors in the form of a $3bn share buyback in May 2013. It also had success as a change catalyst with BMC, Juniper(s jnpr), Brocade(s brcd), and others. Investors keep asking EMC management about a spin-off of VMware, but the company has been clear it sees value in the Federation approach and has no intentions to do so. Despite CEO Tucci potentially turning over the reins in Feb, he takes a long-term view and sees VMware as a critical asset.

Indeed, Tucci has said he will not sell off EMC’s interest in VMware. But, he is now seen as a lame duck; Tucci is slated to retire in early 2015, and this whole federation concept is his baby. It’s unclear what a successor could do with that and it’s also unclear who that successor will be. Of course, Tucci has pushed back a planned retirement before, but he is 66 years old.

Corporate ties that bind

The benefits of this federated structure are not as apparent now.  VMware and EMC are competing with each other more as they each seek to retain their hold in customer data centers or, alternatively the cloud, as customer workloads flow there. VMware has also poached EMC execs.
“VMware’s Hybrid cloud, based on our understanding, does not use EMC storage and competes with many of EMC’s large service provider and cloud customers,” Bernstein Research Analyst Toni Sacconaghi wrote in a research note Monday.
The prevailing view of breakup backers is that VMware is no longer the “little” company EMC bought in 2004 for $625 million. It now represents two-thirds of EMC’s overall value. Citing Factset figures, the Wall Street Journal (registration required) estimated that VMware represents 69 percent (or $40 billion) of EMC’s $58 billion market cap.
With Elliott’s offer, the stage is now set for a showdown. Sacconaghi expects a proxy fight, given that Tucci is expected to defend his federation strategy and he typically has support from the board. EMC is slated to announce its second quarter earnings Wednesday July 23.