What the VMware Stock Price Will Do After Dell Buys Back Shares

It looks like the worst is over for the VMware stock price.

VMware stock priceVMware Inc. (NYSE: VMW) stock has suffered in the wake of privately held Dell Inc.'s planned $67 billion acquisition of EMC Corp. (NYSE: EMC).

Wall Street objected to the deal's implications for VMware, shaving about a third of the value from the VMW stock price in just two weeks.

But now Dell is promising to buy back as much as $3 billion in VMW shares to prop up the VMware stock price.

It's the latest chapter in a convoluted tale that started Oct. 12, when Dell announced the merger with EMC, the largest tech deal ever...

Why the VMware Stock Price Has Plunged

The size and complexity of the Dell-EMC merger, and VMware's role in it, created uncertainty for VMware investors. You see, EMC owns 80% of VMware.

Dell said VMware would continue as a separate, publicly traded company, as it has with EMC. Meanwhile, EMC investors are to receive $24.05 a share in cash and 0.111 worth of VMware tracking stock for each share of EMC stock they own.

The "tracking stock" is a special kind of stock that reflects the performance of a business unit within a larger entity. VMware will be that unit within Dell when the deal is expected to close in mid-2016.

EMC investors weren't crazy about the idea of owning tracking shares of VMW stock, which lack the full rights and protections of common shares. EMC stock is down about 7% since the deal was announced.

VMware investors got more bad news just a week later when EMC and VMware said they planned to create a jointly owned company, Virtustream. The joint venture would have saddled VMware with a money-losing business while requiring it to pay out as much as $250 million in capital spending to get the project running.

Yesterday (Monday), under pressure from institutional shareholders, EMC and VMware killed plans for the joint venture. That's taken some pressure off the VMware stock price.

But Dell's disclosure of plans to buy $3 billion worth of VMW stock will have a bigger impact. It shows Dell is worried about the sudden and steep fall in the VMW stock price. And so far the announcement has worked.

At mid-day today (Tuesday), the VMW stock price is up 1.88% to $58.33.

But this activity has raised a key question - what do investors do with VMware stock now?

Is VMware Stock a Buy?

While Wall Street hasn't liked the impact of the Dell-EMC deal on VMware, the company is a strong player in the virtualization and cloud markets.

VMware, in fact, is the fastest-growing part of EMC.

"VMware is well positioned to capitalize in the growth of data centers, software-defined infrastructure (compute, storage, network, security, management and automation), cloud computing (private, public and hybrid), and mobility," Gabelli & Co. analyst Hendi Susanto said today in initiating coverage of VMW stock with a  "Buy" rating and an $84 one-year price target.

The recent 30% drop in the VMware stock price has left it undervalued. It has a forward price/earnings ratio of about 14, modest by the standards of tech stocks. The consensus price target is $75.75, approximately a 30% gain from where VMW is trading now.

Eventually, VMware's strengths will push the stock back to its previous levels and beyond. For any investor that had their eye on VMware stock, the Dell-EMC deal just handed them a steep discount. And those who own VMW shares should hang on - the stock will rebound in 2016.

"The discount undervalues VMware's highly attractive product portfolio, long-term growth opportunity, high operating profitability, strong free cash flow, and strong data center product portfolio," Susanto said.

Another Way Investors in VMW Stock Could Win

That said, there is one more possible catalyst for the VMware stock price. Dell had to take on about $40 billion in debt to finance the EMC deal and is actively looking for ways to pay for it. Yesterday, for example, Dell said it wanted to sell its Perot Systems unit for $5 billion.

While Dell will be tempted to keep VMware for its cash flow and growth potential, a sale of VMware would likely fetch north of $30 billion. That would pay for most of the EMC acquisition and put Dell on far more solid financial footing.

It would also reward any investor who buys VMW stock now, because a deal would value the company in the $75 to $80 a share range at minimum - about where they were trading before the EMC deal was announced.

The Bottom Line: Dell is talking about buying back $3 billion worth of VMW stock to undo the damage its acquisition of EMC has done to the VMware stock price. That and the decision not to make VMware party to an ill-conceived joint venture with EMC removes two key reasons for the stock's recent 30% plunge. Given this company's strong growth prospects, VMware stock is a bargain right now.

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About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

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