EMC Faces $10 Billion Test to Beat Breakup Call: Real M&ABrooke Sutherland
EMC Corp. needs to convince investors that keeping the company together is worth more than the estimated $10 billion that could be unlocked in a breakup.
Activist investor Elliott Management Corp. has built a stake in EMC and is pushing the $58 billion company to spin off its publicly traded VMware Inc. software unit, according to a person familiar with the matter. While the average of five analysts’ estimates signals a breakup could unlock more than $10 billion in shareholder value, Royal Bank of Canada said management has a point in arguing that a split would weaken the parts and harm growth.
“This looks good on paper, but because of the strategic value of that asset, it might not be that practical to spin it off or sell it,” Rajesh Ghai, a New York-based analyst at Macquarie Group Ltd., said in a phone interview. “There are reasons why EMC is structured this way.”
EMC needs to do something to boost its stock price, according to Cantor Fitzgerald LP. The shares climbed just 1 percent in the three years before reports of Elliott’s stake, compared with a 52 percent rally for the Standard & Poor’s 500 Index. The content management and security divisions are less integral to EMC, which makes storage computers, and spinning off those assets is an alternative that could create $5 billion for shareholders, Macquarie said. Or EMC could consider more share repurchases or dividends, said Janney Montgomery Scott LLC.
Representatives for Hopkinton, Massachusetts-based EMC and New York-based Elliott declined to comment.
Elliott has accumulated more than $1 billion in EMC stock, said a person familiar with the matter, who asked not to be named because the information isn’t public. Splitting with VMware could make EMC an attractive takeover target for technology giants including Oracle Corp., said the person.
Investors frustrated with the laggard stock may be receptive to Elliott’s proposal, Steven Milunovich, a New York-based analyst at UBS AG, wrote in a report yesterday.
Even after EMC rose 5 percent yesterday, it still has a lower price-earnings ratio than the median for peers larger than $5 billion, according to data compiled by Bloomberg.
While the company’s primary information storage business has been under pressure as more businesses shift to cloud storage, the unit is worth more than shareholders are giving it credit for, said Brian Alexander of Raymond James Financial Inc.
Investors are “not really valuing EMC on a sum-of-the-parts basis because they haven’t had a reason to,” Alexander, a St. Petersburg, Florida-based analyst, said in a phone interview. Using a breakup to highlight “the valuation of core EMC, which we would argue is very depressed, makes a lot of sense to us.”
EMC’s core business is valued at about 7.8 times estimates for earnings per share over the next year, Bill Choi of Janney wrote in a report yesterday. That’s almost half the multiple of pure-play rival NetApp Inc., he said.
On average, analysts estimated that a breakup would boost EMC’s share price to as much as $33.60, 19 percent more than yesterday’s close. That equates to about $10.8 billion, data compiled by Bloomberg show.
Today, EMC shares gained 0.7 percent to $28.52. VMware rose 3.3 percent to $96.03.
Just because a breakup looks attractive financially in the short term, that doesn’t mean it’s the best strategy for EMC, said Amit Daryanani, an analyst at RBC Capital Markets, a unit of Royal Bank of Canada. Severing the ties between EMC and VMware risks undermining expansion at both businesses, he said.
“I can make the case that EMC storage does much better in VMware-centric environments versus non-VMware,” the analyst said in a phone interview. “The federation grows faster than the standalone entities would.”
One example of how closely EMC and VMware work together is their joint venture called Pivotal, which will help the companies gain relevance in cloud computing.
VMware’s software that lets computers run different operating systems also gives the company an advantage as it competes with large rivals such as Oracle, Cisco Systems Inc. and International Business Machines Corp., said UBS’s Milunovich.
“If you break it up, you just weaken every part,” EMC Chief Executive Officer Joe Tucci said at a conference in May. “So I just think it’s better together.”
EMC would also still be a big takeover target even without VMware and getting rid of the holding wouldn’t increase the likelihood of a deal, said Daryanani of RBC.
Still, the entry of an activist investor “was a long time coming,” he said. Whether or not the company decides to pursue a breakup, Elliott’s involvement should at least spark conversations about how to boost shareholder returns, he said.
“There’s a lot of value at EMC, but it’s not being appreciated by the market,” Brian White, a New York-based analyst at Cantor Fitzgerald, said in a phone interview. “That’s what they need to grapple with -- how do they show that value to shareholders?”
One alternative to separating VMware from EMC is to spin off smaller assets, such as the content management and RSA security divisions, said Ghai of Macquarie.
“Those are two businesses that could easily be hived off to unlock some value that’s probably not being reflected in the shares right now,” Ghai said.
It’s also possible that EMC instead decides to focus on returning more cash to shareholders with a dividend boost or increased stock buybacks, said Choi of Janney.
Ultimately it will be up to shareholders to decide what they think is the best path for the company, said Brent Bracelin, a Portland, Oregon-based analyst at Pacific Crest Securities.
“EMC is an undervalued asset,” Bracelin said in a phone interview. “A breakup would be able to unlock the value probably in a shorter period of time but ultimately, in the long run, does that actually mean that profitability would be higher? Maybe not.”