After years of being majority-owned by another company, VMware Inc. finally will separate from its parent — now Dell Technologies. But the deal will not resolve the underlying issues for the virtualization software maker.
“Compare how Dell’s stock is reacting and VMware shareholders watching the champagne party from afar,” said Dan Ives, an analyst at Wedbush Securities. “For VMware it removes an overhang, but it doesn’t change the fundamental strategic overhang that continues to plague the stock, and they are doing a spinoff at a time when their longtime leader has done an exit stage left to go to Intel.” (VMware CEO Pat Gelsinger left to lead Intel earlier this year.)
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The “Rubik’s cube” of a deal, as Ives called the complicated transaction, has been a long time coming, and something investors have been seeking for nearly two years. Still, it won’t be complete until the end of this year, to ensure that the deal remains tax-free to Dell and its investors, who have the most to gain.
The possibility of this ultimate spinoff first surfaced when Dell bought storage company EMC Corp. in a complex deal in 2016, which included EMC’s 81% stake in VMware, a developer of software that can act like the environment of another operating system on a network. Last year, the Wall Street Journal reported that Dell was actively considering its options for the strategic stake, including a tax-free spinoff of VMware shares. Those options also included buying VMware outright or selling its 81% stake, which would have incurred a significant tax burden.
Now, that is finally taking place, with Dell shareholders reaping the biggest rewards. All classes of Dell investors will receive 0.44 shares of VMware for each share of Dell that they own. VMware will pay Dell investors a hefty dividend of $11.5 billion to $12 billion, of which Dell, the company, will receive between $9.3 billion and $9.7 billion. That money will be used largely to pay off some of its outstanding debt.
The estimated value of the $11.5 billion to $12 billion special cash dividend that VMware will provide to investors ranges from $27.43 per share to $28.62 per share, based on outstanding shares as of March 16, the company said.
“We do believe that deleveraging in the next two years is important,” Zane Rowe, VMware’s chief financial officer and interim chief executive, said in a call with analysts. “We do believe we will get a lot more flexibility out of the balance sheet as well.”
In order for the deal to close, Dell must receive a ruling from the Internal Revenue Service deeming the transaction tax-free. As previously reported, the spinoff will not be possible until September 2021, five years after Dell’s merger with EMC, to meet the tax requirements.
The companies plan to continue their current business agreements, and collaborate and co-engineer products for customers. But the removal of this overhang from VMware’s stock does not take away its strategic issues. While VMware has been a strong player in the hybrid cloud arena, it is still dealing with the dueling revenue streams of its older, legacy licensing business, with subscription-based revenue for cloud-based customers.
Without Dell’s ownership, VMware is now truly on its own for the first time in many years, but without a permanent CEO. Whoever eventually takes the helm needs to assure investors that they can make VMware stand out on its own.