Can EMC Remain Independent?

My Wall Street buds are convinced EMC is going to be acquired by Cisco. I alluded to the possibility of an EMC merger in this post and started to develop a scenario as to why it’s inevitable. While I think it’s quite possible I don’t think it’s as much a fait accomplis as do some and I think it makes less sense than I originally thought, especially from the buyers’ perspective.

Scenario for why EMC may be acquired

The traditional IT business is consolidating and becoming an oligopoly dominated by HP, IBM, Cisco, Microsoft and now Oracle.  Being a supplier focused on a single layer of the stack (e.g. storage), once a huge advantage, is now becoming a liability as servers, storage, networks, software and services converge. This integration of the stack is necessary to create application services at a higher level of abstraction to support connections to applications across the network. A strong services capability is more desirable in this integrated world and a natural evolution of a maturing business.

EMC is a ‘tweener,’ not small but not big enough. At a ‘mere’ $15B in revenue it increasingly competes with services giants IBM and  HP who each have a richer portfolio across the stack than does EMC. Oracle’s acquisition of Sun, and now Virtual Iron creates a new powerhouse with an ever-growing services offering. EMC will have greater difficulty competing in this environment and a VMware/EMC/Cisco alliance, while attractive will still be an arms-length relationship.

As such, the theory goes, EMC will have to grow through acquisition or be acquired. The problem is who would EMC acquire? Since it passed on Sun (presumably) there’s really no one left. Dell wouldn’t make sense strategically and to acquire a services company like CSC would be culturally shocking and drag down EMC’s already depressed revenue multiple. Blending in VMware wouldn’t change the picture dramatically as EMC’s dominant ownership is already factored in the valuation.

Here’s a reasonably current picture of acquisition candidates or potential acquirers with market cap, revenue and revenue multiple. I sorted on revenue multiple to highlight those firms that can use stock as acquisition currency and get an instant ROI by converting acquired revenue into inflated valuations. It shows the big five with enormous $100B+ valuations and EMC’s position relatively depressed, despite a majority ownership in VMware. Oracle is in an imposing position and while its multiple will face downward pressure if it maintains Sun’s hardware business, the firm looms large.

Recent Financial Data for Major Players

Recent Financial Data for Major Players

This scenario paints Chaiman Tucci in the corner with one option to maximize shareholder value– package EMC in a deal with VMware and shop it to the highest bidder among those who covet the company, namely IBM, HP and Cisco. Who could blame him for considering this option and clearly EMC and VMware would be a prized asset for one of the big five…maybe.

How the playing surface is changing

I’ve referred to the industry dynamics as a chess game where each move opens new attack lanes. The board however has a new third dimension to it– the cloud. EMC/VMware’s vision of the Private Cloud is intriguing but I think it will take years to unfold and may in part be a solution seeking a problem.

By ‘Private Cloud’ I’m using here the definition put forth by Paul Maritz which is essentially that the Private Cloud is a software layer that provides services to enable information management across internal and external resources, in order to set policies, govern privacy, manage security, and operate both internal and external data centers from a single pane of glass. While this Private Cloud vision has merit and may eventually take hold, I don’t see the evolution of cloud computing requiring the concept in the near-to-mid-term. Here’s why.

First, internal data centers are a resource designed to manage hundreds, if not thousands, of applications optimized for a single customer (e.g., a large bank, insurance company, or pharmaceutical firm). External clouds, on the other hand, essentially optimize a single application (search, video, social networking, retail, etc.) for millions or tens of millions of users. Managing these two entities together may not be the right approach  as the economics, business drivers and ecosystems are completely different.

In addition, the stacks within each of these businesses are incongruous. The internal data center stack is unifying networking, storage, servers, software, and services. This is happening because for IT management, it is becoming too complicated and unproductive to continue to optimize at an individual layer and technology convergence is enabling higher levels of abstraction (e.g. virtualization, FCoE, protocol maturity, etc.).

Meanwhile, unlike the traditional data center, the external cloud stack is not consolidating, it’s exploding into many pieces, including infrastructure, platforms, storage, applications, services, and clients. New companies are popping up everywhere, and competition is occurring at each layer of the stack. Focus is an advantage here – think S3, Parascale, Mozy, Nirvanix, EMC Atmos, etc.

Are these two world’s likely to bridge in the near term?  Probably not that fast. I think new applications will be developed on the external cloud, and the legacy apps that need to be highly secure will stay in the data center of the future. Unfortunately, the data center of the future is a low growth business and while the big five could clearly leverage EMC’s assets do they really want to pay up for EMC’s hardware portfolio when VMware is the crown jewel? Companies like IBM continue to expand their software portfolio to generate better margins and while EMC’s software business is growing, it’s mostly still driven by sales of hardware.

Wouldn’t Cisco be better off recognizing that the traditional IT business is a low growth, ‘squeeze-the-profits’ activity while the broader technology space is exploding into wireless, telecommunications and cloud/consumer services. Indeed, Google and Amazon don’t covet a presence in ‘The Data Center’ because it’s not a long term driver of growth and innovation. Consumer markets are where the action is and probably a better investment for Cisco.

Bottom Line: VMWare’s interesting but with EMC in the package it may not be compelling as a growth strategy. HP and IBM want to expand in higher margin software businesses and Cisco should eye a bigger prize than the data center, the mobile/wireless/telco business. Doing the virtual company thing with EMC will work just fine for Cisco and conserve acquisition resources for more strategic assets.

How EMC can Remain Independent

So where does that leave EMC? Actually in a pretty good position. EMC’s core storage business generates tons of free cash flow and is a great source of funding for EMC’s future. EMC is already organized to compete in this new world of IT and it should continue to view three main business opportunities:

  1. The public cloud competing with Atmos and Decho/Mozy.
  2. It’s core storage business.
  3. Information Management.

Let’s briefly look at each of these.

The public cloud

Atmos is derived from a skunkworks that is meeting a completely different set of requirements than traditional storage. Combined with Decho, EMC is investing in participating in the ‘true cloud’ space with a highly focused model adding value at the storage layer. Atmos and Decho can support a model of selling directly to firms wanting to build storage services and with Mozy, EMC is positioned to sell directly to millions of consumers. No other traditional storage company comes close to EMC’s position and early lead and no upstart can compete with EMC’s tremendous asset base.

While sometimes it appears EMC is struggling to figure out what to do with Atmos and its cloud strategy, the company is in the game and on the curve. If it can figure out how to more deeply entrench VMware in the external cloud space it only adds to EMC’s potential.

Core storage

The traditional storage business is becoming one where customers will increasingly demand storage services to connect to applications across networks. With its VMax announcement, EMC introduced a new architecture that begins to provide infrastructure that can be a common platfom using commodity hardware with a software layer at a higher level of abstraction to manage data and support a network-centric data center. While EMC has not given much of an indication as to how it will integrate commodity components across the portfolio, the company’s strong position in the traditional storage business doesn’t need extensive analysis for this post. EMC needs to continue to execute and exploit the large installed base of existing processes built up around EMC solutions and it will do quite well in my view.

EMC is the storage leader and will continue to lead with pressure from big services companies and commodity hardware-based players. EMC in my view knows how to deal with these challenges and has always been absolutely superb at testing and integration. So it can successfully navigate the data center of the future with a VMware/Cisco/Intel/EMC virutal company approach and compete very effectively.

Information management

To me, this is the most under-appreciated opportunity within EMC one that is vital for the company. The problem with my ‘stay independent’ strategy so far is that the external cloud isn’t big enough yet to offset the lack of growth in the core data center. Information management is the answer.

EMC had the right vision with ILM in Tucci’s early days and never made this vision actionable. The information management space (email archiving, eDiscovery, information risk and value management and ILM) has the attractiveness of being large, high growth and high value add. It’s perfect for EMC but the company hasn’t figured out yet that its approach of shoving everything into a centralized archive is completely wrong, won’t solve the problem and won’t scale. EMC’s (and other vendors’) view of scaling is to buy some time by increasing performance and demonstrating in the lab how much more its new systems can do. It’s all backwards.

First, the information management business is an opportunity that is front and center with CIO’s, legal counsel, records management, the business lines and of course IT. It’s a sales and services dream for a company with the right resources. Symantec is the only company in the upper right hand corner of Gartner’s Magic Quadrant, which is absurd in any market (other than desktop OSes), and the main competitor, Autonomy has it all wrong too. The market is wide open for EMC to dominate because existing solutions are too expensive, don’t scale and don’t solve the real problem.

Specifically, EMC should re-craft its vision of what this market needs and completely re-tool its offering. It should focus on managing data in place, in a distributed fashion, and creating virtual repositories instead of using centralized archives that suck up tons of storage space as a blunt instrument. Every leading vendor will tell you they get this and not a one has a decent auto-categorization engine, a pre-requisite of this vision.  

EMC should put its best A-players on this task and begin investing in and acquiring companies that can bring auto-classification, better indexing, powerful enterprise search and other relevant technologies that are popping up all over the market. Look to firms like Clearwell, Digital Reef, Index Engines, Rational Retention and others that are innovating to solve today’s information management challenges in a way that’s completely different and will scale from a business perspective. While EMC is working with some of these firms today, it is doing so in a way that is advancing its flawed vision. EMC needs a bit-flip and it needs one now.

Finally, when it comes to information risk and protecting value, RSA fits perfectly into a compliance, governance and information management vision. This business approach has the potential to deeply entrench EMC in every large account on the planet but in my view the company needs to stop fretting over the less than stellar P&L performance of the business unit and start investing for dominance.

EMC is largely organized to pursue this independent path but from a sales and marketing perspective I’m not sure it’s quite there. I honestly don’t know enough and have to study this more. Consider this treatise a strawman at getting a discourse going about the structure of the IT industry, how its changing dynamics are impacting competition and ultimately how customers will be respond.

The bottom line for me is that consumers are driving IT innovation in the broader markets and the big five are not that well-positioned for that market. Oracle/Sun with Java and Sun’s telco business is interesting. Microsoft has one leg in the data center camp and one in Amazon/Google land and Cisco has an opportunity to invest in the external cloud/consumer business and grow. HP and IBM’s game plan seems pretty clear.

EMC is much more forward-thinking than most IT companies in this regard and while its traditionally high value business is going to come under increased pressure from services giants and commodity players, it is positioning for the external cloud. Meanwhile, the information management space is a strategic opportunity that EMC can and should dominate by changing its perspectives on what users need and meeting those objectives through an aggressive acquisition strategy that finally makes the ILM vision a reality.

What do you think?

Acknowledgments: Thanks to my colleague David Moschella for pointing the way to many key conclusions in this post.

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