VMware Shrugs Off Shaky Markets

The virtualization-software maker's initial public offering is generating plenty of interest. Can it live up to the expectations?

by Aaron Ricadela

In what could become one of the most successful initial public offerings of the year, software maker VMware went public Aug. 14 with an offering that valued the company at close to $20 billion, rewarded shareholders of majority owner EMC, and could prove a barometer of investors' appetite for new issues during a summer of volatile stock market swings.

VMware, a subsidiary of computer storage and software company EMC (EMC), is selling 33 million shares in an IPO on the New York Stock Exchange. The shares surged early on, rising 76% to $50.95 in late-morning New York trading. That gave the company a market value of $19.1 billion. The shares had traded as high as $55.

VMware said late on Aug. 13 that shares would go for $29 apiece, at the high end of the company's forecast range. Citigroup (C), J.P. Morgan Securities, and Lehman Brothers (LEH) are the lead underwriters, and the shares traded under the ticker symbol "VMW." Sanford C. Bernstein & Co. analyst Anthony Sacconaghi had said in a July 31 report that VMware shares could soon rise to $34 to $39.50, which would value VMware at $13 billion to $15 billion.

Anticipation for VMware's offering has mounted in recent weeks. On Aug. 9, VMware raised the target price range of its shares by $4, to $27 to $29 a share. And two of the tech industry's biggest names have bought in. Intel (INTC) on July 9 invested $218.5 million for a 2.5% stake in VMware, and will add an executive to VMware's board. On July 27, Cisco Systems (CSCO) said it's paying $150 million for 1.6% of the software maker. VMware technology helps IT departments make more economical use of servers, the powerful computers that run Web sites and corporate data networks.

A Leader in the Pack

VMware's rapid growth and escalating value have led analysts to compare it to software industry high-fliers like Microsoft (MSFT) and Oracle (ORCL) in their early days. But VMware Chief Executive Diane Greene says in an interview that the landscape has been changed dramatically by the rise of Internet-delivered applications and open-source software. "The tech industry is very different from what it was when they were growing," says Greene. VMware's exacting standards for hiring and product quality have let it stream out "major new innovations on a regular basis," she says. "If we keep executing on that model, it's promising, but it is a different world."

Brent Bracelin, a senior research analyst at Pacific Crest Securities, says he's bullish on VMware because of its large available market, dominant share, and technical advantages over competitors. VMware's sales rose 89% in the second quarter. "This is one of the most important software companies since Oracle, Microsoft, and companies that ruled the last decade," he says. "This is going to be a hot deal."

The scant number of VMware shares on offer could also buoy demand. The offering could raise $957 million. By contrast, the median amount companies have raised in IPOs through the second quarter of this year has been $83.6 million, according to market researcher VentureOne, a Dow Jones (DJ) company.

The IPO could be a boon for investors in EMC, which will own 87% of VMware's shares. The company has said it plans to use proceeds to buy back shares of its stock, and EMC could also pay its shareholders a future dividend in VMware shares, Bracelin adds (see BusinessWeek.com, 2/9/07, "EMC's Billion-Dollar IPO"). Shares of EMC stock rose 7.5%, to $19.05, on Aug. 13.

Navigating a Competitive Market

As desirable as VMware's shares may be at the outset, the company will need to use proceeds from its sale to navigate an increasingly competitive market characterized by rapid growth, profit margin pressure, and the imminent entry of software giant Microsoft.

In particular, the sale gives VMware, which already has 3,000 employees, new currency to attract and retain top talent in Silicon Valley, where it's based. VMware employees had been issued options to buy EMC stock, which has languished over the past three years, says Bracelin. "You're trying to recruit the same pool of talent that Google's in, but you're issuing stock that's been dead money for three years," he says.

EMC is spinning out part of VMware into an uncertain environment on Wall Street. Since late July, stock markets have gyrated amid concern over subprime mortgage malaise. Investors have feared that tightening credit could slow corporate growth. That has led the Federal Reserve, the European Central Bank, and other central banks to inject hundreds of billions of dollars into global markets to prop them up (see BusinessWeek.com, 8/10/07, "Markets: Keeping the Bears at Bay").