Buy, Sell or Hold: Six Reasons That VMware Inc. (NYSE: VMW) Shares Are Poised for a Breakout

I've always been a hands-on kind of person.  And that includes information-technology (IT) projects. While it has been a number of years since I was involved in a serious IT project - with most of that work having been done before I started and ran my hedge fund - I have worked on Website projects for a number of S&P 500 companies in the past. 

I am comfortable around large IT projects, so I was a bit shocked when I realized how much VMware Inc. (NYSE: VMW) had changed the basic structure of the game while I was gone. That point was driven home when I volunteered to head a major IT project for a local city; it turned into a project-manager job that has involved making director-level decisions.

It didn't take long for me to realize that the city needed to deep-six its computer system and start over: Hardware from the late 1990s and early 2000s just won't cut it in a world that's on the doorstep of 2011. The key to this future is the virtualization of operating systems. This virtualized operating system also serves as a basic building block of the new "cloud-computing" technology that everyone seems to be talking about in the land of IT.

Virtualization has changed the way IT departments operate, and there is no one better in the sector than VMware.  Let me share with you some current firsthand experience with building a modern supercomputer for a local city, and which demonstrated to me that VMware is the literal "gold standard" for virtualization in the IT sector.

The Six Reasons to Own VMware Shares

VMware is at the heart of the next generation of servers, Internet functionality and productivity gains.  Let's review how this Palo Alto-based player is destined to dominate its sector. The company has:

  • A first-in-class software package that is used by more than 100,000 clients.
  • $2 billion in cash with no net debt.
  • A core competence in "green software," which helps save energy.
  • A position as a true sector leader and real global growth - despite the penny-pinching mentality so many corporations are maintaining in the aftermath of the worst financial crisis since the Great Depression.
  • A professional support network that's so efficient that - in the long run - it can actually end up being cheaper than "free" software.
  • So many attributes working in its favor that VMware is poised to be a great breakout stock.

To understand why this is so, let's take some time to understand VMware itself.

An Inside Look at a Blue-Chip Player

Founded in 1998, VMware is a high-tech leader whose shares trade on the New York Stock Exchange (NYSE) under the symbol "VMW." The company has 8,200 employees with $2 billion in sales for 2009, when it was the fifth-largest infrastructure-software company.

The company has no net debt, and is sitting on a cash horde of $2 billion.

The company has a market cap of roughly $34 billion, with insiders and institutions holding 93% of the outstanding shares.  There is also a major short position, with more than 8% of the share float short. The number of shares held short dropped last month by almost 1 million shares.

I love to find a niche leader with no real debt and a pile of cash, and shorts scrambling to cover.  In my opinion, there's a nice, secure moat around this company's business plan. In today's world of financial stress, I love to find big fat moats around key niche players. 

VMware specialize in building the software that is used as the host operating system on the new modern-standard-server hardware.  This standard-server hardware is stacked in a dense stack, called a rack. These racks can hold up to 42 individual server units, each based on a standardized 1U format.

VMware is a middleware software package that sits between the hardware itself, and your different software server installs.  VMware has a software package that is based on the Linux software project. The software is installed on each of these units, and then these individual units are combined into a high-density computing package.

I also find VMware's stock to be highly intriguing from a technical trading point. At Friday's closing price of $89.12, VWware shares are trading at the high end of their 52-week range of $40.21 to $89.18.  

The stock has obviously regained all the ground that it lost in the crash of 2008 - its low was $18.94 back in late November of that year - although it remains about 30% below the all-time high of $117 it achieved in November 2007. But that latter point is actually a positive - the stock now appears to be poised for a breakout - and a run to a new all-time high. When I look at a chart, VMware shares demonstrate a nicely bullish cup-and-handle formation.

In the current IT project that I'm involved with, we're using seven of these high-density machines.  When you include three additional support servers, the package of 10 boxes contains as much CPU power as the 116th most powerful computer in the world had available in 2000.  The computer we are building has 68 cores, and more than 150 gigabytes of random-access memory (RAM).

If you combine three of these machines - using the first as the hot server, a second as a "warm" backup machine and the third as a dedicated data-storage server - you can build a system that will provide services uninterrupted even if the primary server has a total hardware failure. 

While there are other companies that offer virtualization software, none of them have the commercial set of tools available for a small IT department to centralize their multi-physical servers into one machine, or a small group of machines. 

I downloaded and tested the other providers, from the Free Industrial Server farm software called XEN, to the Microsoft solution.  In the end, the basket of solutions with the dedicated professional support of VMware proved to us to be more valuable than deploying a free-based software package without support.

Action to Take:  "Buy" VMware Inc. (NYSE: VMW). VMware has just reported great earnings, in the middle of a toppy market.  Let's look to use a little weakness to put our full position on.
(**) Special Note of Disclosure: Jack Barnes holds no share or known exposure in VMW. He is planning on using VMware as the final solution for his server build at the city.

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