climbing a mountain with a pick axe

Michael Dell and Joe Tucci were probably expecting to have celebratory Thanksgiving dinners. Having orchestrated what some are calling the largest (and probably most complicated) tech deal in history, a gratitude-filled, bountiful feast would seem in order. 

But the Dell founder and the EMC Federation chairman had reason enough to get indigestion instead, courtesy of VMware analysts and shareholders whose ideas might vary from theirs, as well as from VMware CEO Pat Gelsinger’s.

You see, from almost the moment Dell made the deal with EMC, VMware stakeholders haven't found much to be thankful for — VMware shares dropped 10 percent shortly after the deal was announced. And the company’s shares have been down as much as 30 percent in the past six weeks.

It’s worth noting that VMware is a publicly traded company that is mostly owned by EMC.

Boiling Point

Though multiple reasons could explain the free fall, the spotlight now is on Virtustream, a cloud computing company that EMC and VMware agreed to build as a joint venture. It was announced after the Dell deal was made. Under the proposed terms VMware would keep the new, money-losing business (Virtustream is a young company with great potential that needs substantial investment to grow) on its books, which would not only hurt its bottom line, but also drag down the value of VMware’s “tracking shares” that were supposed to make the Dell deal more palatable to VMware investors.

It seems to have done the opposite.

Last week, in a note to investors, Daniel Ives, an analyst at FBR Capital, wrote “Virtustream was just the latest in a string of frustrating moves that VMware investors have grown accustomed to over the years and is now hitting a boiling point as seen in the VMware sell-off debacle over the last six weeks.”

Cloud Dreams

Though some seemingly unsubstantiated reports state that, in order to quiet VMware shareholder concerns and their impact on the Dell deal — which has yet to close — EMC has now agreed to carry most of Virtustream’s burden on its books. No official announcement has been made and neither EMC nor VMware is willing to comment.

If the reports are true, Pat Gelsinger’s substantial cloudy dreams could very well be squashed. VMware’s cloud strategy is based largely on vCloud Air, whose future VMware seems to have tied to Virtustream. 

In VMware’s Nov. 9 SEC filing, the company wrote, “if we do not form a new cloud services business with EMC, our vCloud Air business may suffer, and it would be difficult to successfully execute a standalone hybrid cloud strategy.” 

Gelsinger and Ajay Patel, general manager at vCloud Air at VMware, have also said that they envision Virtustream to be a top-five cloud service provider, globally.

This is something that Gelsinger has had on his mind for a long, long time. Consider the statement he made in 2013, speaking to a convention of VMware partners:

“We want to own corporate workload … We all lose if they end up in these commodity public clouds. We want to extend our franchise from the private cloud into the public cloud and uniquely enable our customers with the benefits of both. Own the corporate workload now and forever.”

VMware President Carl Eschenbach went a step further:

“I look at this audience, and I look at VMware and the brand reputation we have in the enterprise, and I find it really hard to believe that we cannot collectively beat a company that sells books.”

Give Me Time

While Gelsinger may now be working overtime trying to convince VMware investors that the Virtustream deal will be, in the long run, a huge win for all, Ives and others like him are unlikely to buy.

In fact, shutting down Virtustream, or at least getting it off of VMware’s books, may be only a first step in their minds. Consider that the analysts are practically parroting each other.

Bernstein analyst Toni Sacconaghi wrote, “EMC and VMW are likely reconsidering the Virtustream joint venture (it has been announced, but not legally consummated) given the shareholder backlash and subsequent negative impact on VMW's shares.”

Wells Fargo analyst Maynard Um noted that, “While this (shutting down the Virtustream as it is presently structured) would be a step in the right direction, by itself, we do not think it would completely appease some investors.”

Ives wrote that, “EMC and VMware will potentially shut down this Virtustream initiative which would be the first step towards rebuilding goodwill with investors.” 

Totally Unexpected?

It’s unlikely that the discontent among VMware investors comes as a total surprise to Gelsinger. VMware’s 10-Q includes some telling language concerning the Virtustream deal:

“Although we previously announced our intention to complete the transaction, we have not yet signed, and may not ever sign or consummate, definitive agreements. VMware’s level of ownership in Virtustream and the ongoing effect on VMware’s financial results have not been determined, and definitive agreements may contain terms materially different from those announced. The cloud services business would increase our investments in the cloud services space, which is intensely competitive and dominated by large companies with very strong balance sheets, and we may need to invest capital into Virtustream on an ongoing basis.”

Consider the Competition

With language like that, investors will likely further scrutinize their risks, which might include looking at who else wants to build an enterprise cloud business. There’s Oracle to consider which promises that it has a hybrid cloud offering. Google may be a strong contender as well, especially now that it has hired VMware co-founder Diane Greene to lead its enterprise cloud efforts. With her brains, connections (she initially built VMware’s customer base from scratch) and Google’s deep pockets even Microsoft and Amazon have taken notice.

At this point it seems that the future of Virtustream, VMware, EMC and Dell might be as much about appeasing investors and closing the deal as strategically building out the future of enterprise technology. 

Title image by Jared Erondu