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EMC Buys a Virtual Lifeline

By Faith Arner After bragging for years about its growing cash hoard, EMC (EMC) is finally putting its money where its mouth is. The data-storage outfit is spending $635 million on what could be its most important deal, if not the largest, to date: The acquisition of VMware, a privately held software producer based in Palo Alto, Calif.

Who? The business that most nontechies have never heard of could be crucial to EMC's survival as an independent company. Battered by plummeting hardware prices, EMC has been struggling to make higher-margin software a larger part of its business. With VMware, it does one better: It moves beyond making software that manages storage devices to offering tools that also help info-tech managers get more bang out of their Intel (INTC) servers.

CATERING TO CONSOLIDATION. Several tech analysts think that's key to EMC's future as rivals IBM (IBM) and Hewlett-Packard (HPQ) challenge it in the storage market. "EMC has to be worried that somehow they'll find their software locked out even if it's better software," says Robert Passmore, research director at tech researcher Gartner. "So the obvious strategy is to do the whole thing themselves."

VMware focuses on what's called server virtualization (VM stands for virtual machine). Its software essentially carves up one server into multiple machines, allowing it to run several operating systems -- such as Windows or Linux -- at once. A server typically runs only one at a time. IT managers gain flexibility and can do more with less, allowing data centers to further consolidate gear.

Consolidation remains a top priority in the IT world, according to an October survey of IT chiefs by William Blair & Co. The 1990s' buying binge led to tech "spread" that many businesses have found difficult to manage. Now they're aiming to rein it in. "Companies are trying to make their environments easier to mange by consolidating purchases around fewer strategic vendors and centralizing IT," according to William Blair analyst Laura Lederman.

NEW ARMS RACE? The VMware deal could complicate EMC's relationship with arch-rivals IBM and HP. Moving into server management places EMC in another area of direct competition with the two giants, which both sell servers and management software. But VM is a leader in the server-virtualization market, and both IBM and HP resell its wares. Whether they'll continue to do so after the EMC deal closes early next year and become partners with EMC -- or set off a new arms race in the data center -- remains to be seen.

The acquisition marks EMC's third major software buy this year. But it's the first cash transaction, reducing EMC's stash of cash and investments from $6.2 billion at the end of the third quarter. It used stock for the $1.3 billion purchase of Legato Systems in July and the $1.8 billion deal in October for Documentum.

Founded in 1998, VMware has 360 employees and has been profitable in its most recent three quarters. Revenue is forecast to come close to $100 million this year -- double last year's level. EMC expects VMware to bring in nearly $200 million in 2004.

EMC plans to take a charge of $15 million to $20 million in the first quarter of 2004 for in-process research and development costs and other integration expenses. That will knock a penny off its estimated earnings per share of 6 cents for the first quarter -- but it won't hurt projected earnings of $660 million for 2004 on revenue of about $7.5 billion. EMC expects VMware to chip in a penny to 2005 earnings. Arner is a correspondent in BusinessWeek's Boston bureau

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