EMC faces challenges from VMware's rivals

BOSTON - EMC Corp. cannot celebrate very long after spinning off a 10 percent stake of its VMware Inc. software unit in what became the biggest technology stock offering since Google Inc. went public three years ago.

The initial public offering has enriched EMC and opened new opportunities for the largest vendor of corporate data storage and services. But challenges also threaten to dull some of the luster of its 2004 acquisition of the fast-growing maker of "virtualization" software for $625 million - an investment that yielded a big payoff Tuesday.

What had been one in a string of small-company acquisitions by EMC to diversify beyond its traditional storage-hardware niche now has a market value of about $20 billion.

That's slightly more than half the $38 billion market capitalization of EMC, of Hopkinton, Mass., which owns 86 percent of VMware and controls 98 percent of the voting stock.

VMware has captured more than 80 percent of the market for virtualization, which helps data centers get more processing capacity from server computers. VMware's products allow a single machine to run multiple programs and operating systems.

"In the past six years, VMware hasn't really had any competition," Gartner Inc. analyst Tom Bittman said.

But now, EMC and VMware, of Palo Alto, Calif., must fend off moves by the likes of Microsoft Corp., which is expected to enter the fray next year with a virtualization product code-named Viridian. A far-smaller virtualization player, XenSource Inc., also in Palo Alto, got a potential lift this week when Citrix Systems Inc. purchased it for $500 million. Another small player is Virtual Iron Software Inc. of Lowell, Mass.

Bittman said VMware has been able to set its software prices based on the expected savings from virtualization for customers who would otherwise have to buy more hardware to accomplish computing tasks. But with open-source versions of virtualization products emerging - and even VMWare offering certain products for free - prices will come down.

"Now, if you have competition that says 'we can do the same for a lot less,' that changes the landscape," Bittman said.

Since EMC bought VMware, it has been EMC's star, consistently posting quarterly revenue gains of about 90 percent. It's on pace to break $1 billion in revenue this year - while EMC as a whole projects nearly $13 billion.

Under EMC's ownership, VMware has expanded from about 300 employees to 3,000, and EMC even built a new Silicon Valley headquarters for the unit - for which VMware now owes EMC $127 million under terms of the February agreement that led to the stock offering.

VMware's growth prospects, now expanded by the nearly $1 billion raised in its IPO, could increase EMC's opportunities to pitch more of its storage hardware and services alongside VMware's software as data centers upgrade.

But EMC must still convince information-technology managers that its products would be better fits than those from such storage rivals as International Business Machines Corp., Hewlett-Packard Co. and Network Appliance Inc.