Two weeks ago, Michael Dell made the big announcement that Dell Technologies would spin off their shareholding in VMware, leading to a share price spike for both companies. A lot has already been written about the move – we would like to highlight a market-based view which we feel will be significant for the two companies going forward.
First let us break down the facts around the deal:
As has been analysed threadbare the deal reduces the total debt Dell is carrying and will even reduce the ratio of Dell debt to EBITDA. As a result, it is highly likely that Dell’s credit rating will move up from their current BB+ level to investment grade – which can have a lot of implications for future capital raising. There is also a buzz in the market that Dell Technologies may also sell off Boomi soon and write down another USD 3 Billion approximately in debt.
It is interesting to note that the company has been willing to let go off VMware even though it will dilute their profitability ratios – VMWare business being obviously more profitable than Dell’s traditional businesses which are heavily based on products.
The last few years has seen Dell reselling a fair amount of VMware products. From a number of perspectives Dell has been a key reseller for VMware and now contributes almost 34% of VMware’s revenues.
This chart is a testament to the power of execution that is inherent within Dell. This performance was aided by market growth – but even then it is remarkable how Dell has been able to scale up taking VMware to their customers. The two companies have very different sales cycles. A VMware sale typically has a longer cycle with a completely different set of touchpoints from the boxes that Dell is so good at selling – which have shorter cycles. The sales cycle for EMC products is closer to VMware’s which would have helped. The sales of the VXRail hyperconverged appliance have also jumped in recent times and this would have driven an equivalent spike in VMware revenues. It is still a remarkable achievement to be able to bring these three diverse groups together and grow revenue.
Market Impact of the Spin-Off
Does it make sense then for VMware to part with their largest reseller? Would it not be better for VMware to continue to drive this and use Dell’s execution skills to drive more growth? Data suggests that there could be another twist to this story.
VMware has been growing impressively as a company when one looks at the black line and while the growth has slowed in percentage terms, this is on a much higher revenue base. FY2021 revenue is close to 2x the revenue in FY2014. However, when one considers it without the Dell reselling revenue (the red line) it looks a lot less impressive especially in the last couple of years when it is an anemic 3%. When comparing this growth we also see a slowdown of sorts in recent years for VMware.
Til Dell acquired EMC – and VMware in consequence – they were working closely with other vendors such as Nutanix and driving solid growth for them. As they pivoted to doing more with VMware, did this then mean that other vendors – of either bare metal or cloud – drifted away from VMware?
Anecdotal evidence suggests that vendors such as HPE became more cautious and tried to diversify their business. It is entirely possible that if we looked at VMware as two separate businesses – one with Dell and one independent – the independent business has been losing share in the last few years.
The optical separation from Dell may then help VMware in rebuilding stronger relationships with the other players in the market including the hyperscalers. This may fuel further VMware growth. To do that VMware will have to manage a balancing act:
- On the one hand keep growing their reseller revenue with Dell. They are on a good wicket so far and need to make sure this continues. While the revenue from appliances – which come loaded with VMware – is a sure-fire proposition, other growth needs to be harvested carefully. Dell has a multitude of offerings and taking their eyes of the VMware ball is super easy.
- Build trust and closer ties with the other vendors to keep driving revenue. VMware’s leadership in the market means they already have ties with other industry leaders like HPE, AWS and so on. These will need to become much deeper; VMware will need to build the trust that they will give these vendors equal status even as they are building new appliances with Dell.
The one complicating factor here is that Michael Dell remains the Chairman of the Board of VMware. This may give other vendors pause and they may still want to keep their options open instead of putting all eggs into the VMware basket.
Ecosystm Comments
VMware is at a fairly critical inflection point in their business. The growth of cloud technologies still bodes well for virtual machines which has been their mainstay, but this is also likely to drive growth for more containerisation. They have great products for that part of the business also. However, as container adoption is likely to explode VMware would not want vendors to shift, to say Red Hat, and develop deeper partnerships with them or other competitors. They would like to keep the vendors on VMware – be it a virtual machine or a container. One does feel the future battle for VMware really rests on how well they will be able to grow in the container space. This will have to be done while continuing to innovate to keep the lead in the virtual machine space. Doing it will be quite a feat!!
Finally, what then of Dell? The company seems to have a talent for running businesses which are in long-term secular decline – but running those businesses well. Their PC business is delivering almost 7% operating income and has continued to show growth. The PC market last year was on fire thanks to the pandemic which dramatically increased the demand for devices – growth was double digits for a market which has declined almost every year since 2011. As Dell is fond of saying the PC industry has sold over 5 billion machines since the PC was declared dead!
The server market seems to have stagnated over the last couple of years which is a bit of a surprise given the growth in cloud. Dell’s revenue has declined two years in a row pointing to possible issues which need fixing in that part of the business.
As the company focuses on these key challenges in the market it probably makes sense for them to lower their debt and earn more freedom to operate. One never knows – given the number of surprises that Michael Dell has engineered over the last decade such as taking Dell private, acquiring EMC, stabilising it, then going public again, making a windfall in the process – if he has some other rabbits yet to be pulled out of his hat!!!
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Last week, NVIDIA announced that it had agreed to acquire UK-based chip company Arm from Japanese conglomerate SoftBank in a deal estimated to be worth USD 40 billion. In 2016, SoftBank had acquired Arm for USD 32 billion. The deal is set to unite two major chip companies; power data centres and mobile devices for the age of AI and high-performance computing; and accelerate innovation in the enterprise and consumer market.
Rationale for the Deal
NVIDIA has long been the industry leader in graphics chips (GPUs), and a smaller but significantly profitable player in the chip stakes. With graphic processing being a key component in AI applications like facial recognition, NVIDIA was quick to capitalise. This allowed it to move into data centres – an area long dominated by Intel who still holds the lion’s share of this market. NVIDIA’s data centre business has grown tremendously – from near zero less than ten years ago to nearly USD 3 billion in the first two quarters of this fiscal year. It contributes 42% of the company’s total sales.
The gaming PC market has been the fastest-growing segment in the PC market. The rare shining light in an otherwise stagnant-to-slightly declining market. NVIDIA has benefited greatly from this with a huge jump in their graphics revenues. Its GeForce brand is one of the most desired in the industry. However, with their success in AI, NVIDIA’s ambition has now grown well beyond the graphics market. Last year NVIDIA acquired Mellanox – who makes specialised networking products especially in the area of high-performance computing, data centres, cloud computing – for almost USD 7 billion. There is clearly a desire to expand the company’s footprint and position itself as a broad-based player in the data centre and cloud space focused on AI computing needs.
The acquisition of Arm though adds a whole new dimension. Arm is the leading technology provider in the mobile chip market. A staggering 90% of smartphones are estimated to use Arm technology. Arm is the colossus of the small chip industry – having crossed 20 billion in unit shipments in 2019.
Acquiring Arm is likely to result in NVIDIA now having a play in the effervescent smartphone market. But the company is possibly eyeing a different prize. Jensen Huang, Founder and CEO of NVIDIA said “AI is the most powerful technology force of our time and has launched a new wave of computing. In the years ahead, trillions of computers running AI will create a new internet-of-things that is thousands of times larger than today’s internet-of-people. Our combination will create a company fabulously positioned for the age of AI.”
With thoughts of self-driving cars, connected homes, smartphones, IoT, edge computing – all seamlessly working with each other, the acquisition of Arm provides NVIDIA a unique position in this market. As the number of connected devices explodes, as many billions of sensors become an ubiquitous part of 21st century living, there is going to be a huge demand for low power processing everywhere. Having that market may turn out to be a larger prize than the smartphone market. The possibilities are endless.
While this deal is supposed to be worth around USD 40 billion, somewhere between USD 23-28 billion is going to be paid in the form of NVIDIA stock. This brings us to an extremely interesting dynamic. At the beginning of 2016 NVIDIA’s market cap was less than USD 20 billion. Mighty Intel was at USD 150 billion. AMD the other player in the market for chips who also sell graphics was at a mere USD 2 billion. In July this year, NVIDIA’s value passed Intel’s and today it is sitting at around USD 300 billion! Intel with a recent dip is now close to USD 200 billion. AMD too with all the tech-fueled growth in recent years has grown to just shy of USD 100 billion market cap.
What this tells us is that the stock portion of the deal is cheaper for NVIDIA today by around 55% compared to if this deal was consummated on 1st January 2020. If there was a right time for NVIDIA to buy – it is now. This also shows the way the company has grown revenue at a massive clip powered by Gaming PCs and AI. The deal to buy Arm appears to be a very good idea, which would establish NVIDIA as a leader in the chip industry moving forward.
Ecosystm Comments
While there appears to be some good reasons for this deal and there are some very exciting possibilities for both NVIDIA and Arm, there are some challenges.
The tech industry is littered with examples of large mergers and splits that did not pan out. Given that this is a large deal between two businesses without a large overlap, this partnership needs to be handled with a great deal of care and thought. The right people need to be retained. Customer trust needs to be retained.
Arm so far has been successful as a neutral provider of IP and design. It does not make chips, far less any downstream products. It therefore does not compete with any of the vendors licensing its technology. NVIDIA competes with Arm’s customers. The deal might create significant misgivings in the minds of many customers about sharing of information like roadmaps and pricing. Both companies have been making repeated statements that they will ensure separation of the businesses to avoid conflicts.
However, it might prove to be difficult for NVIDIA and Arm to do the delicate dance of staying at arm’s length (pun intended) while at the same time obtaining synergies. Collaborating on technology development might prove to be difficult as well, if customer roadmaps cannot be discussed.
Business today also cannot escape the gravitational force of geo-politics. Given the current US-China spat, the Chinese media and various other agencies are already opposing this deal. Chinese companies are going to be very wary of using Arm technology if there is a chance the tap can be suddenly shut down by the US government. China accounts for about 25% of Arm’s market in units. One of the unintended consequences which could emerge from this is the empowerment of a new competitor in this space.
NVIDIA and Arm will need to take a very strategic long-term view, get communication out well ahead of the market and reassure their customers, ensuring they retain their trust. If they manage this well then they can reap huge benefits from their merger.
Last year Microsoft announced it was developing a new version of Flight Simulator which caught many of us by surprise. Flight Simulator? Really? The last launch of a new version of the game was in 2006 – 14 years ago, now!! How does something come back after all these years?
Now that it has launched about a week ago, the initial feedback has been extremely positive and it appears that Microsoft has a winner here. An analysis even claims that it will spur $2.6 billion in hardware sales of PCs, game accessories and the like!
I wanted to unpeel the onion a bit to take a closer look at what is going on and discovered a world of interesting developments around this product.
My first thoughts on hearing the announcement was that Microsoft, who has been steadily losing the battle of consoles to Sony’s PlayStation platform, was reviving this old favourite to resuscitate its drooping share.
Not a bad move. Flight Simulator has a core of die-hard fans – it even boasts of professional pilots who play the game as relaxation. It has a long history and a captive fan community. But it is old. That loyal community is not part of the demographic that a gaming company would normally look at today.
The other interesting aspect to consider is the COVID-19 situation this year. Obviously, Microsoft did not know this at the time they embarked on this project but the pandemic has turned everything on its head – hardware sales are through the roof – including accessories, at a time when people have been homebound and looking for entertainment within the four walls of one’s abode. The Ecosystm Digital Priorities in the New Normal study finds that 76% of organisations increased their hardware investments when the crisis hit – and 67% of organisations expect their hardware spending to go up in 2020-21. And that is only on the enterprise side of things. On the consumer side, at this point joysticks are in short supply – a trend that seems to have been accelerated by the Microsoft launch last week, interestingly – and so are PCs. The PC vendors are all enjoying a bumper year of growth. This is an ideal time to launch a really cool new version of the game.
Microsoft’s Bigger Game
The reality however is that while Flight Simulator will add to the revenue and also give Xbox One a fillip, Microsoft is probably after a much bigger “game” (excuse the pun!). The company has called its ‘Xbox Game Pass’ the Netflix of the gaming market. With multiple cloud-based gaming platforms having been launched – many with subscription services – the battle is on to decide the winners in a relatively new space. To this end, Microsoft has announced an intention to make Game Pass available across different devices – XBox console, PCs, tablets, phones. Having a title like Flight Simulator available through Game Pass, will act as a key hook to get customers to sign up for the subscription.
The new Flight Simulator version has been developed using AI and real-world imagery brought in with data from Bing Maps. With the newly added realistic scenery, it also seems like a great fit for use with the HoloLens Virtual Reality headsets. In one shot Microsoft is showcasing their lead in areas of technology which are likely to prove attractive to developers in a big way. I believe that this is a way for them to entice more developers on to Azure and to Microsoft cloud to develop their games – “AI SDKs anyone? Virtual Reality tools anyone?”
What seems at first glance like the launch of a new “future is here” version of a great game will turn out to be a possible big swing at multiple targets by Microsoft – at leadership in gaming with Game Pass; at reviving Xbox fortunes; at leadership in game development platforms, with Azure packing AI services, Bing Maps, AR/VR tools, among other technologies to move more development on to the Microsoft cloud. In the process Microsoft launched a highly enjoyable game and got closer to their ultimate aim to indeed become the Netflix of gaming.
Great move Microsoft! Tip: This could also give them a foothold in the virtual travel and virtual vacations market! That would be a hot seller in these times.