Tuesday, September 9, 2008

VMWare (VMW) Special Shareholder Meeting

I have been so busy, I thought today was VMware's (WMW) annual shareholder meeting. I picked up my materials and ran off to the 8AM meeting in Palo Alto, only to realize my mistake. VMware was only holding a special meeting to vote on whether to approve a one-time stock option plan. Basically, the company's stock price has gone down significantly, causing most of its employees' options to be underwater. My understanding is the meeting today was held because VMware wanted to replace existing stock options with newer ones.

CEO Paul Maritz gave a short presentation, and the the stock option plan was approved after confirming a quorum. Mr. Maritz seems honest and smart. He has a British accent, and took questions from the few shareholders present (four of us), even though the format of the special meeting didn't require him to do so. The meeting lasted only 20 minutes, and only coffee was served.

I asked about the tax consequences of the stock option plan. The CFO answered that because the options had not been exercised, there was "no significant impact" tax-wise. Once the employees exercised their new stock options, the company would be able to record a tax deduction, which would actually benefit the company (but of course, dilute existing shareholders).

I asked a question about what the company does. I am not a born techie, so the concept of virtualization and virtual machines is strange to me. (Every time I hear the term, "virtual machines," I think of the Borg and T2's "Rise of the Machines.") Peter Lynch's advice, "Invest in what you know," worked well in the past, but these days, it's hard to follow that simple rule.

The CEO Maritz very politely attempted to answer my question about the company's products. He said the company is a software company involved in "virtualization." VMware software "fools" other software/hardware platforms, allowing greater functionality. Previously, users had to have different machines to run different operating systems, but now they can use just one machine. For example, VMWare's software allows users to run Windows and Apple's Leopard on the same computer. CEO Maritz went further, saying VMware is a "data management/IT company." It manages the computer environment, and the company had "700 third party customers."

Another shareholder mentioned Larry Ellison and how Mr. Ellison had grown Oracle by not selling his software outright, but requiring users to subscribe to it. CEO Maritz indicated VMware has different pricing plans, just like Oracle.

Overall, I left the meeting feeling like I was in the presence of professional, dedicated people. I still don't know what virtual machines are, or how they really work, or how a company can monetize such an asset, but I will ask more questions at the annual meeting next year [see below--I did more research into this issue and have provided an explanation of VMware's benefits].

One interesting item in the special meeting report: beneficial shareholders of VMware include Intel Corporation (18.30%); and Cisco Systems International (6.88%). As mentioned above, due to having greater voting rights, WMware is basically owned by EMC Corporation, which holds 97.17% of the Class B shares and "98% of the voting power of outstanding common stock" (page 48, Form 10-Q).

Another interesting item: VMware gives its partners access to its source code and hypervisor for development purposes, which may create IP issues later on.

The end result of today's meeting for me? I picked up more shares of EMC afterwards. I figure it's a safer bet to invest in the quasi-parent company than in the newer company, at least initially (e.g., buy Cypress Semiconductor rather than Sunpower) , because spin-offs usually saddle the newer company with debt. I am concerned about the market's volatility, but now seems like a good time to slowly add to positions.

Update on 9/10/08 and 9/15/2008: I understand EMC's business, i.e. information storage, but I haven't seen anyone adequately explain "virtualization" and how to monetize it over a long period of time. Here is how EMC explains virtualization: "virtual infrastructure solutions and services [enable] customers to run multiple operating systems simultaneously on the same physical machine." Again, that sounds nifty, but why would a company give x dollars to VMWare for this?

If anyone can explain VMWare's product offerings and whether VMWare can prevent its software or its products from becoming commoditized as more players enter the market, please submit a comment. Thank you.

Update on 9/15/08: I've done more research into what VMware does and spoken with a patent agent and a VMware employee. Basically, an obvious but key piece of information to understand is that the computer industry and the software industry are not homogeneous. As a result, certain software can only run on certain platforms and certain operating systems. Tech companies' failure to homogenize their products provides an opening for a company that can provide one piece of software ("middleware") that allows one machine to run all necessary software and to communicate across different platforms. Think of a fruit drink seller. In the tech world, the fruit drink seller would need one blender for blueberries, another one for strawberries, and another grinder for oranges, and none of them could work together. VMware allows the fruit drink seller to use one blender for all the different fruits. As for continuing to monetize the one blender after its sale, the blender will need upgrades as more and more fruits get introduced, allowing VMware to continue to get paid.

Here are the benefits of VMware in more detail:

1. Virtualization fools a piece or hardware into thinking it can run multiple applications on multiple platforms. So in the past, a company might have needed ten different pieces of software with ten different licenses and ten different IT employees just to maintain different department functions, like payroll, receivables, exports, etc. Now, the company just needs one IT employee, one piece of hardware, and can buy a multi-user license for all the software they need. A multi-user software license is far cheaper than buying each individual software license separately.

2. VMware increases safety while maintaining diversification. Many companies buy different software they need from different vendors, but the vendors don't collaborate, causing incompatibility. This incompatibility sometimes necessitates owning several different pieces of hardware, depending on what the company needs. In addition, companies don't like having all their company functions on one piece of software or relying on a single operating system--if there is a failure (think Windows Me, or the earlier versions of Windows Vista), the entire company might have to shut down or an upgrade might cause company-wide problems. VMware changes all that. It allows the company to have one piece of hardware that can run multiple platforms and software programs. In having one piece of hardware, the failure rate decreases, but without decreasing your options. It's like having a single video game console that can run Nintendo Wii, XBox, and Playstation games.

3. Statistically speaking, VMware reduces risk. VMware requires only one piece of hardware. If a company has 100 different pieces of hardware, it increases the potential failure rate. For example, if you have 100 people walking across a busy street, the potential of having 1 person get hit out of 100 is much higher than if you just have one person walking across a highway. Basically, having 99 other people there means there's 99 extra chances for someone to get hit. (My intuition tells me I haven't given the best (or even the right) example for this concept, but it's the best I can do at this late hour.)

I hope this post helps laypersons and non-geeks understand VMware and its products.

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