A Skittish Moment for EMC


By Andrew Park The tech-industry recovery is in full swing, but investors still get the jitters if they sense caution from market leaders. Thus, on Jan. 25, after data-storage giant EMC (EMC) posted better-than-expected numbers for the fourth quarter of 2004 and predicted more strong growth this year, its shares slipped 2.8%, to $12.48. It was the Hopkinton (Mass.) company's lowest close in three months.

The culprit: A comment that gross margins could fall slightly in the first quarter, thanks to price wars and shortages of certain key components. "There's some conservatism in there," CEO Joseph Tucci said of EMC's expectations during a conference call with securities analysts.

What gives? One look at EMC's financial performance reveals a company at the top of its game. Compared with the year before, fourth-quarter earnings rose 46%, to $871 million, on sales of $2.36 billion -- a 27% increase. For all of 2004, net income was up 76%, while sales increased 32%. Revenues should grow an additional 20% in the first quarter and 14% to 16% for the year. Earnings per share should rise to between 47 cents and 51 cents for the year, compared with 36 cents a share in 2004, and operating margins should rise to the high teens, Tucci says.

"GOOD SHAPE." What's more, EMC is gaining market share across its product lineup, which has expanded significantly, thanks to a $3.6 billion shopping spree in 2003 and 2004. Revenue from the three biggest acquisitions -- Legato, Documentum, and VMWare -- surged 19%, 25%, and 150%, respectively, last quarter. Legato and Documentum each topped $100 million in quarterly sales for the first time since being bought by EMC.

And in EMC's core-hardware business, it continues to benefit from a broad array of offerings, especially its lower-priced Clariion line. Quarterly sales of Clariion boxes, much of which are made by third parties, including Dell (DELL), rose 46%, to $393 million.

Sales of higher-priced Symmetrix gear grew only 3%, but EMC said that was enough to take market share from competitors. "EMC is in as goodhape as it has ever been, or better," wrote Goldman Sachs analyst Laura Conigliaro in a note to clients not-so-subtly titled, "We Would Buy EMC Shares Now." Investors already may be taking heart, since EMC shares bounced back to $12.78 on Jan. 26.

PLAYING DOWN EXPECTATIONS? Still, the bears' case was bolstered when EMC began talking gross margins, a key indicator of a company's ability to balance costs and pricing. Since storage-hardware pricing collapsed in 2001, Tucci has worked hard to restore gross profitability to boom-era levels, principally by boosting revenues from software and services. In 2004, these categories accounted for 52% of overall sales, compared with 46% the year before, and gross margins reached 51%, up from 46%.

Momentum slowed on the margin in the fourth quarter, however. Tight supplies of disk drives for high-performance storage hardware drove up costs up while aggressive pricing eroded expected revenues. And, Tucci said, both headwinds will remain strong in the first half of 2005. The result: Gross margins could fall in the first quarter and will grow only slightly for the full year, to about 52%.

A number of analysts believe EMC will easily surpass that target, though. Its earnings guidance has consistently proved conservative over the last two years, noted Sanford Bernstein's Toni Saconnaghi in a report to clients. EMC exceeded its top-line forecast for the year by $400 million. A similar rise would give it ample opportunity to increase gross profitability, as would higher sales of software and services, says Saconnaghi, who recommends buying EMC shares between $12.50 and $12.75.

FACTORS IN ITS FAVOR. And EMC may be responsible for some of the pain itself. As IBM (IBM) has delayed the availability of its newest high-end storage system, dubbed Shark, EMC has been circling the waters, luring Big Blue's customers with aggressive discounts, says Brian Babineau, an analyst with Enterprise Strategy Group, a Milford (Mass.) consulting firm.

"EMC was out to gain share from IBM," he says. Look for EMC to keep the pressure on until Shark arrives in volume sometime next month, Babineau says.

Increasingly, customers are placing less and less emphasis on sheer storage horsepower. That should favor EMC's broad, balanced market approach and help it maintain, and perhaps expand, its top market share.

By all accounts, this is a company firing on all cylinders. Park is a correspondent in BusinessWeek's Dallas bureau


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