EMC 2 (EMC) Analyst: Saheb Saini Fall Recommendation: SELL Target Price until (06/30/2015): $24.51

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1 Recommendation: SELL Target Price until (06/30/2015): $ Reason for Recommendation: Over the past three years, EMC has recorded higher revenue growth each year, and this will likely continue in 2013; however, as the market gets saturated and competitors become dominant, EMC will struggle to maintain the same percentage of revenue growth. Moreover, the industry is currently shifting from traditional data storage to cloud-based computing, and EMC has not kept pace with its competitors in terms of this innovation. The data storage industry is on a growth trajectory but the traditional data storage market is saturating as many users are shifting to cloud computing therefore, EMC's dominance in this market is likely to fade. The company has forecasted a revenue of $22.50 billion in 2013, an increase from 2012 s $21 billion 1. However, a recent press release reported the company fell short of its third quarter projection, which signals a slowdown in respect of growth. It has also decreased its forecast for future revenues because of lost revenue from the government shutdown and losing contracts to its competitors 2. Also, as many companies enter this market to grab industry share, EMC s competition will increase. Increased competition decreases revenues because companies lower their prices to attract buyers who are presented with multiple options The information industry is highly reactive to new technological innovation. The latest technology to gain prominence among data storage consumers is cloud computing. EMC is a market leader in database storage and virtualization of the data through its information infrastructure and VMware but it hasn't gained enough popularity in cloud computing segment yet and other big market players such as Amazon, Apple, Microsoft and Google have entered the market with the advantage of having a strong user database providing a greater competitive edge. These new entrants also have an advantage of better brand value. VMware is the market leader in virtualization of data, but currently 70% of the market is saturated and obtained, which has slowed the growth EMC experienced over the past 3 years 3. EMC is threatened by the potential entrants in the market. Many of the technology companies are entering into the cloud computing market to grab a share of this growing industry. Entrants such as Amazon and Apple are already in the market with cloud computing because they have large databases of consumers they can market the service to. Microsoft's virtual computing firm Azure is giving tough competition to the rapidly growing VMware. In the information technology industry, entrants rely on new technology development and information technology companies which breeds on technology innovation and invention determining companies growth. EMC had a consistent P/E ratio from with an average of In 2012, EMC's P/E ratio had a sharp decline to , which is likely to continue. Considering EMC s last three quarters and its projections for the end of 2013, I predict its P/E ratio will be at and will remain around for 2014 and The decrease in P/E ratio could be interpreted as growth in EMC s revenue resulting 1 EMC Press release - 3rd Qtr EMC Press release - 3rd Qtr Gartner Insights 4 EMC - 10K EMC - 10K 2012 pg. 1

2 in higher net income and earnings, which does not corresponds with the past three year s stock price that indicate the company s revenues to be saturating with bearish stock price. In my opinion, EMC's incentives plans for its executives is not a good strategy. It is based on predetermined performance goals, which are largely based on the revenue recognition by EMC. This model can lead to potential manipulation in revenue recognition by the executive so they can receive higher bonuses. Positive Factors In the United States, the industry is at a growth stage and will continue to be for the next 5 years at 4.5% annually 6. It could be assumed that as the technology improves and is embraced by the developing nations, the scope of the industry will grow even at a higher rate. The database storage and cloud computing is a less capital intensive industry as it requires hardware and software that are mostly outsourced. EMC is an industry leader in data storage and virtualization with a market capitalization of $49 billion 7. It has more than 2,600 patents and trademarks registered 8. Since its establishment, EMC has acquired more than 70 companies, which has allowed it to diversify into information storage, backup and recovery, virtualization, cloud computing, data computing, Information security and Intelligent information services 9. It has won a number of awards such as World's most admired computer companies, top 100 global innovators and best workplace in Europe 10. It is also known for its green initiative and environment friendly ecosystem-based processes. EMC s latest press release stated, a strong year to year revenue growth has been achieved from BRIC + 13 other countries 11. Besides Hitachi, Japan and a few Dutch companies, the international market has no big competitors in this industry. Other countries do not have the expertise and resources to build complex systems for cloud computing and information infrastructure, which gives U.S.-based companies an advantage as a supplier of this technology. Thus, the international market remains open from business; however, recent reports of NSA spying could impede EMC s ability to grow in the foreign markets. 6 IBIS Report 7 EMC - 10K report EMC - 10K report EMC - 10K report EMC - 10K report EMC 10Q 3rd 2013 pg. 2

3 2.Company Analysis EMC 2 Corporation is an information technology-based company primarily in the business of providing a wide range of services to enterprises for storing, managing, protecting, analyzing and securing their online data through traditional data centers, virtual data centers and a cloud based information technology infrastructure. EMC Corporation manages its business under two categories: EMC Information Infrastructure and VMware Virtual Infrastructure 12. EMC Information Infrastructure has three sub categories: a) information storage, which offers a wide range of services for enterprises to store their data and applications. EMC 2 Corporation has a market capitalization of $49 billion 13 and reported a revenue of $21 billion in Its financials indicate 69% of the revenue generated from the information storage, 24% from VMware Virtual Infrastructure and 4% from Information Intelligence group and RSA division collectively, Pivotal at 3% 15. The report also indicates that the revenue increased 8.5% in 2012 and 17.6% from the year before. Much of its revenue comes from U.S markets at 60% followed by markets in Europe, the Middle East and Africa at 21%, Asia at 14% and Latin America at 5% 16. EMC is projecting a decrease in revenue growth because of the government shutdown in October. It will not be able to meet its projected growth rate for Strengths The information technology industry is bullish, and in particular the storage and cloud computing segments have witnessed a rapid growth. The industry will continue to grow at 4.5% for the next 5 years 17. EMC is well established in the market and has a huge database of existing consumers using EMC products. It is also a very strategically run and diversified company with more than 7 segments. It has 2600 registered patents and trademarks, which provides it with a niche in the industry and presents an obstacle for other technology companies to infringe upon EMC. It has also seen rapid growth in the three past years, and with the right product development, it has the potential to commercialize the product in the market. EMC is also well established in the international market. The latest press release reported EMC has recorded revenue growth in BRIC+13 nations 18. Weaknesses The traditional storage market and the virtualization market are saturating thereby decreasing EMC s revenue. EMC has an undefined pathway to cloud, which limits its ability to restructure its business model towards cloud computing thus resulting in a competitive disadvantage for EMC. Its stock price has remained stagnant for the past 3 years even after rapid revenue growth and net income. EMC's information infrastructure segment is likely to grow at a very slow pace for the next 2 years and then decline due to technological changes and industry shifts. 12 EMC - 10K report Reuters 14 EMC - 10K report EMC - 10K report EMC - 10K report IBIS report 18 EMC 10Q 3rd 2013 pg. 3

4 Opportunities EMC is well positioned with registered users using EMC products. It has also an establish brand value in the market. EMC needs to start shifting to cloud computing aggressively to expand its business and increase its market share in that segment. It is also important to build up strategic partnership with key industry players to sell VMware products to big industry players such as Amazon. EMC should focus on increasing demand from the international market thus increasing its market share. Threats Industry shift from traditional information infrastructure to cloud computing poses a huge threat for EMC. Big industry players such as Amazon, Apple, Google, Microsoft entering the cloud computing market with better resources can change the business structure of the industry. Innovation based technology industry strives on changing technology. EMC is not only competing with tech giants but also small companies as they remain more connected to consumers and their needs due to lean business models. pg. 4

5 3. Industry Analysis The information infrastructure industry develops and supplies infrastructures for database storage systems and cloud computing systems. The key economic drivers for this industry are private investment in computers and software, Internet traffic volume, number of broadband connections, price of semi conductor and electronic components, international trade relations, international economic factors, and foreign currency and regulations. In the United States, the total industry size is estimated at $68 billion per year and is at a growth stage, which will continue for the next 5 years at 4.5% annually 19. As the technology improves and is embraced by the developing nations, the scope of the industry will grow at an even higher rate. Database storage and cloud computing are less capital intensive industries because they require hardware and software that can be easily outsourced. The information and infrastructure industry is highly volatile due to rapid technological changes. Large companies that use database storage and backup and cloud computing industry comprise 70% the total information infrastructure market 20. The small firms and consumer market remain an opportunity because they comprise 25% of the total market and have not been tapped by any of the big players. Because there are open software available online, small firms and consumers are becoming more concerned with online security and safeguarding private data. Also, the international market is a prominent market because there are no big global players and since it is a technological based sector and therefore highly dynamic, other countries will be hesitant to invest sizable capital in research and development. The level of competition is very high within the database storage and cloud computing industry. In 2013, the four largest firms are estimated to have 74.8% of the total share 21. It is expected that the already high level of competition will rise in the next 5 years through mergers and acquisition. Also, constant change in technology will be a significant factor on the firms as they strive to adapt and grow further in the market. The information technology Industry is highly consolidating. There are very few players in this industry. Technological giants such as Microsoft, IBM, Oracle and EMC 2 are competing against each other. They are able to offer a wide range of products and services to their client, which makes the smaller firms less attractive to the consumers. The smaller companies also are often unable adapt to rapid technological changes due to limited human capital and cash and thus ends up getting bought by the bigger firms. 19 IBIS report 20 Mergent 21 Mergent pg. 5

6 Appendix: Valuation using multiple F 2014 F 2015 F Stock price Diluted EPS Sales $13, $14, $14, $17, $20, $21, $23, $24, $25, Shares outstanding Sales per shares P/E P/Sales per share E/P 4.24% 4.55% 3.77% 4.51% 4.41% 6.57% 5.66% 5.93% 6.13% * Analyst's own calculations. Source of basic data: company's 10-K pg. 6