VMware analyst details 3 things weighing on the stock

James Fish, director and senior research analyst at Piper Sandler, joins Yahoo Finance Live to discuss VMware stock and the outlook for the company after reports that it will be acquired by Broadcom.

Video transcript

JULIE HYMAN: That's VMware with these reports that Broadcom is in potential talks to acquire the company. First, I guess, I would ask, what has gone wrong with VMware? Because I was looking at the stock chart and it's been languishing, really, ever since mid 2019. So it peaked a lot earlier than the rest of the sector.

JIM FISH: Yeah, that's a good question. There's been really three things. One is the Dell divestiture, where, obviously, VMware had to pay a special dividend, for example, to Dell shareholders and spin out. And there was a lot of debate as to, is that a good thing for VMware, or is it kind of an issue longer term, even though there's a five-year kind of commercial relationship with Dell?

And then, secondly, it's going through a very painful process as a public company of moving from this perpetual business model to both term and cloud subscription. And when-- in doing so, we've had margins kind of come down, come down, come down. And we're kind of in the worst of it at this point. And so, we've said that next fiscal year, not the current one, will be the trough-- or that we should get the inflection point in the next fiscal year, and we're currently in the trough part of margins.

And so, we've just seen free cash flow, kind of similar to Zoom, have to come down in terms of expectations. And so, when you're really not growing free cash flow, you're going to be in this kind of 10 to 15 times free cash flow range, like VMware has been. And then just the final point is this idea around public cloud, can VMware actually monetize public cloud workloads as well as it did in private cloud and on-prem? And they've got a ton of workloads that they're helping their customers to manage, but you can tell, just based on the monetization of the workloads that they have, it's just not as big of an opportunity for them as it is on-prem.

JULIE HYMAN: So you're not necessarily painting a picture of a terribly attractive asset for the likes of Broadcom, at least not at this point. That said, with Michael Dell's 40% stake in VMware, there's talk about maybe something like, what, a 46-- well, it's rising today. Do you think he'll push for a higher price than the market perhaps is ascribing to this deal?

JIM FISH: Yeah, I mean, I'm not as smart as Michael Dell, so I'll let him make that judgment call. But overall, when you look at what VMware has done over the last few years-- and, you know, it is kind of in this kind of troughy part of its transition. Could there be a further push for a greater price? Sure, we've kind of said it should be somewhere between probably 125 to 135 a share, which would get you roughly 16 times the next 12-month cash flow, not too far off from other acquisitions, more so done on the private side, but, like, Citrix being taken out recently by Evergreen, for example, is a similar multiple for a similar kind of setup and story overall.

So we don't think it's necessarily-- you don't have too much upside here in terms of that range. But we'll see where the greater powers kind of put out the price and all of that. And there are synergies here. And talking with my colleague, Harsh Kumar, we went through kind of the smell test behind what Broadcom typically looks for. And there is a path there to potentially 70% operating margins, which is what Broadcom has done with its CA and Symantec acquisitions together. But you would need to cut about half of OpEx. So there's a big synergy number being talked about. And it would have to result in 70% operating margins more than likely.

JARED BLIKRE: Well, we've got to leave it there, but I just want to say, our editor-in-chief, Andy Serwer, over at Davos, actually, ran into Michael Dell this morning. And he asked him if he had any comments on the transaction, to which Michael Dell smiled and replied, no comment. So he's not talking about it today. Always good to see you here, Jim Fish, Piper Sandler director and senior research analyst.