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How a Dell and VMware merger could affect EMC storage

Enterprise storage stalwart EMC was majority owner of VMware and now may wind up a subsidiary if Dell merges with the virtualization giant. Dell said no decision has been reached.

Whatever strategic alternatives Dell Technologies and its VMware subsidiary pursue, storage experts say the outcome will not change much for those companies' products and technologies.

Dell CEO Michael Dell told his employees last week the vendor's leadership is considering options such as going public or completing a reverse merger with VMware, which Dell owns most of and is already traded publicly. Those moves could help reduce the billions of dollars of debt the company took on when it acquired EMC and VMware for more than $60 billion in late 2016.

Dell also said in his email to employees that one option is "business as usual" for Dell and VMware.

Even if Dell and VMware decide to merge, Dell EMC storage customers are unlikely to be affected, said Scott Sinclair, a storage analyst at Milford, Mass., research firm Enterprise Storage Group.

"I don't believe this would have an impact on Dell EMC customers, negatively or positively. From my perspective of talking to customers after the Dell EMC merger, their reaction has been pretty favorable. I think the only thing that would change would be the company's accounting structure," Sinclair said.

Dell Technologies may decide that retaining its current ownership structure makes the most sense, said Roger Cox, a Gartner research vice president of data center infrastructure and management, via email.

"This strikes me as financial re-engineering, perhaps driven by the new tax codes or the desire for Michael Dell and [Dell investor] Silver Lake to monetize their holdings," Cox wrote in an email. "I see no strategic advantage for Dell Technologies to issue an IPO or execute a reverse acquisition with VMware. Nor would it seem reasonable for Dell Technologies to sell off VMware, [which] many people believe is the crown jewel of Dell Technologies."

Even so, Cox said Dell EMC storage competitors will try to take advantage of the merger-related talk.

"I do think this situation further enhances competition [as rivals] take advantage of the uncertainty surrounding the state of Dell Technologies, particularly in the enterprise storage market that is already under stress," Cox wrote.

EMC owned most of VMware shares before the Dell acquisition. EMC spun off VMware as a public company in 2007, although EMC owned most of the shares. Dell, who took his own company private in 2013, did the same with EMC but kept VMware public. A reverse merger with VMware would enable Dell to become a public company again without completing another initial public offering (IPO).

There are several scenarios in which a leveraged buyout could occur. VMware could try to sell additional shares to either buy outright or reduce Dell's outstanding debt, which stands at nearly $53 billion. That figure includes $46 billion related to the EMC deal.

VMware is generating lots of cash for Dell Technologies, but it needs to do some major acquisitions or innovations to stay in the game.
Greg Schulzsenior advisory analyst, Server and StorageIO

After buying EMC, Dell said taking it private would alleviate the need to meet shareholder expectations every quarter. But the entire company could be publicly held again if Dell goes for an IPO or reverse merger.

"Given Michael Dell's past statements about staying clear of the public market, doing an IPO [for EMC] seems kind of precarious," said Greg Schulz, a senior advisory analyst at Server and StorageIO in Stillwater, Minn. "Dell might just want to buy full control of VMware's revenue stream, which would give them the advantage of the public market, without the baggage of doing an IPO.

"VMware is generating lots of cash for Dell Technologies, but it needs to do some major acquisitions or innovations to stay in the game," Schulz added.

VMware is facing headwinds as companies increasingly choose the public cloud as a storage tier. VMware in November acquired software-defined networking company VeloCloud Networks to support customers that need to run applications in any cloud.

Open source Linux-based containers are maturing, giving customers wary of VMware licensing fees a different virtualization option. Perpetual licenses account for the lion's share of VMware revenue, although sales of consumption-based subscriptions are growing at three times the rate of VMware's overall business.

Still, between Dell and VMware, VMware remains a moneymaker. The virtualization giant posted $1.98 billion in revenue on net income of $443 million when it last reported quarterly earnings in November. Revenue was up 11% year over year and 4% sequentially. Meanwhile, Dell EMC external storage sales have been flat since the merger. One area of growth for Dell EMC is its VxRail hyper-converged appliance, which includes VMware software with Dell PowerEdge servers.

Dell paying down debt from EMC deal

Dell has paid down about $10 billion of debt since the EMC acquisition, although debt obligations are set to peak around 2021. Motivation for a Dell and VMware hookup may be traced to newly enacted U.S. tax reform, which caps corporate interest deductions at 30%. 

In his memo to employees last week, Michael Dell said the vendor is in a "position of strength" to consider a range of strategic options. He identified an IPO of Dell Technologies and a business combination of Dell and VMware as options, along with the business as usual possibility.

"Nothing has been decided and alternatives are just being considered at this stage," Dell wrote in the note. He did not provide a timetable on when a decision might be reached.

Dell was required to publicly disclose its deliberations in filings with the U.S. Securities and Exchange Commission. VMware said in a separate filing that Dell ultimately may decide on "maintaining the status quo," and that a sale of VMware is not under consideration.

VMware "is not in a position to speculate on the outcome," VMware CEO Pat Gelsinger said in a statement.

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