Software // Enterprise Applications
Commentary
10/16/2003
04:55 PM
William Schaff
William Schaff
Commentary
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Taking Stock: EMC Moves To Ease Integration Headaches

EMC's acquisitions could get it closer to its revenue goals

Woke up this morning at the delightful hour of 4:30 West Coast time to start listening to East Coast earnings calls. I figured the most exciting earnings news to hit me would be Intel after the market close. I was wrong.

Out of the blue, EMC reveals its plans to acquire Documentum, a document- and Web-content-management software company. I was surprised at first but realized that EMC needs to acquire some parts for its strategic road map. Earlier in the year, EMC moved to acquire Legato Systems, an enterprise-software company that focuses on backup, recovery, and archiving of information across distributed systems. Now it's getting a company focused on document and Web management. EMC is already the market leader in storage and storage-related software. The clear argument from EMC is that, with these acquisitions, clients will be able to buy the vendor's storage offerings and integrate new hardware into an existing infrastructure with minimal headaches. The new applications can be applied to open distributed systems and can be used with more than just EMC offerings.

Of course, EMC's competitors are likely to say: How can software be truly neutral if it's being supported by only one hardware vendor? Hmmm. Good point. It will be interesting to see whose perspective wins out in the long run.

The deals make sense for EMC, because they get the company closer to its overall revenue goal of 30% software sales by 2005, and it's paying with somewhat inflated stock currency. The Documentum deal is 2.175 shares of EMC stock for every share of Documentum. The deal for Legato, expected to close shortly, is for 0.9 shares of EMC for each share of Legato. If there were 116 million shares of Legato at the time of the deal and slightly more than 52 million shares of Documentum, the total number of EMC shares to be issued will be about 218 million. I believe the combined revenue of the two companies will be around $595 million this year. The sales are roughly 50% software licenses and 50% services and maintenance. The gross margins on software sales are usually around 90%, while services and maintenance tend to be around 60% to 65%. Both gross margins are higher than EMC's 45% gross margin on mostly hardware revenue.

In essence, each newly issued share of EMC stock will buy $2.72 of new revenue and also deliver better gross margins. Before the acquisitions, EMC had 2.194 billion shares outstanding, and I projected 2003 revenue of $6.0 billion. This translates to $2.73 of revenue per share of EMC--roughly equivalent to the acquisition prices. However, given that the profitability of the acquisition revenue is substantially higher than current business revenue, the deal is attractive to current EMC shareholders. I haven't gotten into fair value for any of the companies as I believe we're getting into funny-money land for technology company valuations once again.

Oh, and I almost forgot: Intel beat Wall Street predictions for earnings.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at bschaff@bayisle.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.

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