BOSTON (Reuters) - VMware Inc VMW.N could lose its rich share valuation as a new product from Microsoft Corp MSFT.O and potentially more competition from Oracle Corp ORCL.O threaten its lead in the virtualization market.
VMware shares trade at about 26 times the average Wall Street forecast for next year’s earnings, according to Reuters Estimates. That is roughly twice as expensive as Microsoft, the world’s biggest software maker, and Oracle, the third.
Analysts say VMware shares could be ready for a sell-off if its quarterly results later this month, or its outlook, miss expectations, with Microsoft preparing to ship in July a souped up rival to VMware’s flagship product.
Some warn that VMware has yet to factor in the competitive threat and only two of 31 Wall Street analysts who follow VMware stock advise investors to buy it at current prices.
“For a company that’s got a legitimate Microsoft threat, once you’ve got a multiple in the high 20s, that makes me feel a little bit queasy,” said Goldman Sachs analyst Derek Bingham.
VMware, which is majority-owned by EMC Corp EMC.N, has historically traded at a high valuation because investors expect it to leverage its lead in virtualization technology to quickly boost sales and profits when the economy recovers.
Virtualization improves the efficiency of computer hardware, allowing businesses to replace multiple pieces of equipment with one machine. That helps save money on hardware, maintenance and electricity.
But VMware’s growth has stagnated in recent quarters and some analysts are concerned business may get worse before it improves, especially with competition stiffening.
Prior to its August 2007 initial public offering, VMware’s sales were growing about 100 percent a year. They have slowed considerably since and analysts project revenue growth of 2 percent to $1.9 billion this year, with per-share profit excluding items falling to 91 cents from $1.05, according to Reuters Estimates.
“People want to own the virtualization trend, so they buy the stock,” said Cowen & Co analyst Walter Pritchard. “But I challenge anybody to say that their financial profile justifies the company’s valuation.”
VMware declined comment for this article. The 11-year-old virtualization pioneer posted its first-ever drop in quarterly software sales during the quarter ended March 31. It has yet to release results for the quarter ended June 30, although in April it warned revenue would dramatically miss Wall Street expectations, blaming the economy and a new product launch.
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A year ago, Microsoft introduced virtualization software known as Hyper-V, bundling the program for free with its Windows operating system for servers. Hyper-V included some features for which VMware customers pay thousands of dollars per server, but lacked a critical feature that has kept it from taking off.
That feature -- which VMware calls VMotion -- allows companies to keep “virtual” servers running when the physical hardware fails. It immediately switches workload from one machine to the next.
Microsoft has added that feature to the new version of Hyper-V, a move that analysts say will boost the allure of its free alternative to VMware’s product.
“It has been getting some very good reviews. If I were VMware, I would be looking to lower my prices,” said Laura DiDio, an analyst with Boston-based market research firm ITIC.
Jefferies & Co analyst Katherine Egbert estimates Microsoft already has about 10 to 15 percent market share, compared with about 80 percent for VMware. She projects VMware’s share will shrink after Microsoft releases its upgrade.
Palo Alto, California-based VMware may also soon go up against billionaire Larry Ellison’s Oracle, which is looking to expand into new areas as growth slows in its core markets of database and business management software.
Oracle launched a product targeted at a small segment of the virtualization market in late 2007 and is about to buy two companies -- Sun Microsystems Inc JAVA.O and privately held Virtual Iron -- that could make it a far more serious threat.
“It is clear that Oracle has serious intentions,” said Egbert of Jefferies & Co.
VMware shares, which have risen about 20 percent this year like Oracle and Microsoft shares, closed down 0.6 percent at $28.07 on Monday.
Reporting by Jim Finkle, editing by Tiffany Wu and Andre Grenon
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