EMC Weighs Using $5.65 Billion Cash on Security Startups

Just three years ago, EMC Corp. (EMC) was considered takeover bait. How things have changed: Since then, the world’s biggest maker of storage computers has made 15 acquisitions and its mergers team is figuring out how to use $5.65 billion in cash to bulk up in security technology.

“The biggest area would probably be security,” said President and Chief Operating Officer David Goulden, when asked about EMC’s acquisition plans in a July 25 interview. He said the company had “all the key parts we were looking to put together” in its core storage business.

To fuel growth and repel competition, EMC uses acquisitions and a research and development budget that topped $2 billion last year. It also deployed a venture capital team to monitor emerging companies and turn them into allies before they become threats. EMC needs to show it can keep up revenue growth as an explosion in corporate data and shift to Internet-based cloud computing spurs former partners such as Dell Inc. (DELL) and Oracle Corp. (ORCL) to enter the $64 billion storage industry.

“The market is now saying EMC is likely to be a consolidator and not a consolidatee,” said Chief Executive Officer Joe Tucci, in an interview at EMC’s Hopkinton, Massachusetts offices, where the entryway to the executive suite is decorated with two of EMC’s newest sleek, black, refrigerator-sized storage machines.

Smart Buyers

Potential targets could include firewall companies such as Fortinet Inc. (FTNT) and Palo Alto Networks Inc. (PANW), said Brian Marshall, an analyst at ISI Group who lists EMC as his top stock pick for the next few years. Tony Ursillo, an analyst at Loomis Sayles & Co., said EMC may go for a firewall company, and adds Check Point Software Technologies Ltd. (CHKP) to a list of possible targets.

“EMC and Oracle are arguably the two most savvy acquirers in the entire tech landscape and the two most successful,” Ursillo said.

Reflecting the value the market places on its potential, EMC is valued at 15 times projected 2012 earnings, according to data compiled by Bloomberg, compared with 12 for Oracle and 6 for Dell. EMC shares have gained 19 percent this year, compared with 17 percent for the Standard & Poor’s 500 Index.

While Goulden declined to discuss possible targets, he said security technology needs to be “reinvented” for a new age of cloud computing, where programs and security can be moved together smoothly from server to server.

“There’s a lot of startups doing that kind of stuff now, so there’s a lot of opportunity for us to expand,” said Goulden, who was promoted to president and COO in a reorganization last month.

Traditional firewall and antivirus technology sold by Symantec Corp. (SYMC) and other companies is being upstaged by more innovative products crafted by startups such as Fortinet and Palo Alto Networks.

On Top

Three years ago, financial analysts at firms such as Credit Suisse and Stifel Nicolaus & Co. expected EMC to be acquired by a tech giant like Cisco Systems Inc. (CSCO) or Hewlett-Packard Co. (HPQ) The company was mentioned in Barron’s and the New York Times as a potential target.

EMC was viewed as too small to reach the top tier of technology firms by itself, said Abhey Lamba, an analyst at Mizuho Securities USA. That isn’t a comment you hear anymore, he said. While EMC’s erstwhile acquirers have faced challenges, it consolidated a lead in the storage market. The 2004 acquisition of VMware for $635 million, which Lamba lists as the best technology acquisition of all time, boosted sales growth and thrust EMC into the vanguard of cloud computing.

Fueling Growth

EMC posted annual revenue growth of 18 percent in 2011 and 21 percent in 2010, bolstered by acquisitions, including the $2.25 billion purchase of Isilon Systems Inc. As its biggest- ever takeover, Isilon allowed EMC to serve a faster-growing part of the storage market and fend off competition from NetApp Inc. (NTAP) Sunnyvale, California-based NetApp is the only one among EMC’s peers with a comparable 2012 price-earnings ratio of 16.

EMC’s revenue growth compares with 1 percent for Hewlett- Packard and 4.2 percent for Oracle in their latest fiscal years.

“The key for EMC is continuing to grow in adjacent markets and to look how they can continue 10 percent-plus annual revenue growth,” said ISI’s Marshall.

EMC also keeps a close eye on early-stage startups though a venture capital program. Run by a small team with a budget the company won’t disclose, it takes several-million-dollar stakes in young companies to learn about emerging technologies. When EMC sees promise, it buys the startup, such as the purchase of Israeli flash storage company XtremIO Inc. in May for $430 million.

Turf Wars

EMC’s joint venture with Cisco, forged in 2009 to sell software and gear for data centers, also could fall apart, said Mizuho’s Lamba. He said he expects Cisco -- having expanded into the server market -- to try moving into storage and could buy NetApp, creating a more formidable competitor.

Tucci said although Cisco could try its hand at storage, EMC values the partnership and it’s his “strong, strong desire” to retain it. Yet VMware last month bought Nicira, a software-based networking company and a direct Cisco competitor.

After delaying a planned move from the CEO job until at least the end of 2013, Tucci is unlikely to depart from EMC’s longstanding acquisition policy of buying smaller companies. He said integrating big companies takes attention away from promising new technologies that come with a deal. While larger rivals will expand into wider categories, EMC will be cautious, he said.

“The big players will try and be more and more and more self-sufficient,” he said. “In there presents a weakness, too. I don’t know how you get great at everything.”

Most Opportunistic

Tucci said the industry is about two years into a 10-year wave of change that will be the biggest in the history of information technology: the shift to cloud computing, which allows companies to tap into software online without installing programs onto their own hardware. The trend will be “the most opportunistic” and “the most destructive,” he said.

Now a new shakeout is under way and already claiming victims. Jeremy Burton, EMC’s executive vice president for product operations and marketing, cites Hewlett-Packard as an example of a company that has fallen behind because it failed to keep pace with research and development investments. He also lists Nokia Oyj (NOK1V) and Research in Motion Ltd. as companies that “were giants five years ago and now they look like they’re history.”

Tucci knows the risks. He joined EMC in 2000 when the company was the second-best performer in the Standard & Poor’s 500 Index for the previous decade with products that underpinned the Internet boom. Then the bubble burst, precipitating a two- year slide in EMC’s sales before Tucci was able to turn it around.

“If you get complacent, you’re going to get killed,” he said.

-- Editors: Reed Stevenson, Jillian Ward

To contact the reporter on this story: Dina Bass in Seattle at dbass2@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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