EMC Corporation (EMC): Is VMware, Inc. (VMW) a Value Play or a Trap?

Shares of VMware, Inc. (NYSE:VMW) were up were up 11% this past week, and investors have begun to wonder if the stock has bottomed. Though the company reported solid fourth-quarter earnings that topped Street estimates, management spooked analysts with a soft first-quarter and fiscal 2013 outlook, which sent the stock down tumbling 30%. However, management has been saying all of the right things lately, and it seems that the Street has bought in. I wouldn’t get too excited just yet, though.

Jumping for what?
VMware, Inc. (NYSE:VMW), along with EMC Corporation (NYSE:EMC), which owns 80% of the virtualization giant, recently held a “strategy day,” during which, both companies spoke to analysts about (among other things) the future of the cloud. While VMware is still doing well in this space today, gone is the belief that VMware’s growth will last forever.

However, management wanted to put an end to speculation that this company was being eaten alive by the likes of Citrix Systems, Inc. (NASDAQ:CTXS). To that end, VMware, Inc. (NYSE:VMW) gave some new growth targets that seemed more upbeat. But were they? It projected fiscal 2013 revenue growth to arrive in the range of 11.2% to 13.8% while also saying that this range can go higher to 15% to 20% by 2014 to 2016. Analysts rejoiced, but hold your horses.

First, these aren’t exactly breathtaking numbers. The stock’s valuation and the projected growth still don’t jibe. For that matter, a case can be made that management actually lowered guidance. When VMware reported fourth-quarter earnings, management (then) called for a low end of 14% growth for fiscal 2013, which was (then) 3% less than what analysts were looking for. This was why the stock got hammered by 20% following the announcement.

It’s odd that the stock would now react favorably to guidance that is lower by more than 3%. It seems the Street’s love affair with VMware wants to continue at any cost. I suppose EMC Corporation (NYSE:EMC)’s defense of VMware, Inc. (NYSE:VMW) growth outlook helped. EMC Corporation (NYSE:EMC)’s management said that VMware’s revenue growth should continue to accelerate while also suggesting that cloud and flash trends are not disruptive to EMC Corporation (NYSE:EMC)’s storage business. But was this enough to deserve such an upbeat reaction? Investors need to pause and understand that VMware still has some issues to address.

Is it a value or a trap?
Management had previously warned investors not to expect much growth until the second half of the year. If you want to make the case today that the stock has bottomed, I suppose it’s worth a gamble. But you’re also waging that the worst over. Besides, investors can’t be comfortable with single-digit license growth, while Citrix, which has been stealing market share, recently posted earnings that included a 17% jump in product and license revenue.

This means that VMware, Inc. (NYSE:VMW)’s market leverage is also diminishing. Why, then, when comparing their price-to-earnings ratios, does VMware deserve such a premium to Citrix (48 vs. 39), especially when Citrix outperforms in gross margin and earnings per share? VMware’s management believes it can remain a force. But is there enough virtualization demand to go around? That roughly 65% to 70% of VMware’s addressable server market is already virtualized is a concern.