VMware shares are hot now as Dell deal looks close
Corrections & Clarifications: An earlier version of this column gave the wrong date for when shareholders will vote on EMC's proposed sale to Dell.
EMC says it's getting closer to finalizing its sale to Dell, and that's helped turn shares of its VMware business red hot.
VMware shares surged 14% to $58.53 Wednesday after the maker of virtual-storage software said first-quarter sales were slightly better than Wall Street expectations. It also issued a forecast range signaling second-quarter revenue may also slightly beat analysts' estimates.
Those estimates were slashed in January after VMWare cut its own 2016 sales growth forecast.
VMware also benefited after executives said the company would begin buying back shares once EMC (EMC) shareholders vote on the Dell transaction. The proposed sale will take EMC private but leave VMware as a publicly-traded unit of Michael Dell's holding company, Denali.
"We are working aggressively on finalizing (required securities documents) so we can get to a shareholder vote ASAP," EMC CEO Joseph Tucci said on the company's first-quarter earnings call on Wednesday.
Tucci said the deal has cleared regulatory hurdles in every country except China and re-affirmed that the deal will close in the second or third quarter.
EMC, which owned roughly 80% of VMWare shares when the deal was announced in October, says voting on the deal will instead take place at a special meeting of stockholders, a date for which has not been set.
By reaffirming the Dell deal will close according to its original time frame, EMC helped alleviate investor fears about the transaction that have kept its shares well below the advertised sticker price of $33.15 a share. For a few weeks, they even languished below the $24.05 a share cash price Dell has promised to pay. EMC shares also rose Wednesday, ending 3.2% higher at $26.37.
Those fears include how much debt Denali will be taking on as part of this leveraged buyout.
VMware shares have fared even worse since news of Michael Dell's huge bet became public. Because Dell will pay for part of the transaction with a VMware tracking stock that will dilute its shareholders, those investors ended up on the wrong end of a classic arbitrage trade (sell VMware, buy EMC), which we warned readers about seven months ago.
While the trade was still a money-maker in November, so-called arb trades are temporary and this one looks played out.
Since last fall, Michael Dell has raised more money to help pay for EMC. Those deals include selling Dell's IT services business to Japan's NTT Data Corp. for $3 billion on March 28.
Dell is also in talks to sell several of its software units, according to Bloomberg News, including Documentum and SonicWall, with a goal of raising billions more.
The moves have heartened previously dispirited VMware investors, who watched their shares shed 45% of their value between October 7 and VMware's disappointing first-quarter report in late January.
Disgruntled shareholders were successful in stopping the creation of another new EMC unit that would have added more complexity and risk for VMware investors.
That move, which would have joined EMC and VMware's cloud-computing units and put the cost for combined product development on VMware's income statement, was announced but quickly scrubbed.
With the news of the last 24 hours, the arbitrage selling pressure on VMware looks to be waning fast or already finished.
VMware shares may well post further gains. Longer-term, though, investors weighing holding the shares should keep in mind that analysts cut their growth expectations for the company nearly in half three months ago.
And while future VMware stock repurchases will blunt the effect, the coming tracking stock will still dilute existing shareholders.
EMC shares also look like a trading buy between now and the close of the Dell deal in May, barring unforeseen panics or other bad news.
The stock's rise Wednesday came even after it reported sales fell 2% year over year, as fears over the transaction faded.
Because of its large ownership stake in VMware and the structure of the Dell transaction, any rise in VMware shares will also goose the value of EMC between now and when it's taken private.
So after suffering for months at the hands of arbitrage sellers, the best way to make money on VMware in the near future is to be long, not short.
John Shinal has covered tech and financial markets for more than 15 years at Bloomberg, BusinessWeek,The San Francisco Chronicle, Dow Jones MarketWatch, Wall Street Journal Digital Network and others. Follow him on Twitter: @johnshinal .