VMware: Back Into Buying Territory

• VMware's fourth-quarter beats were eclipsed by news that Dell could enter into a reverse merger with VMware, shattering hopes of a total buyout by Dell.

• Shares are down 6% on the news, especially as Dell reportedly plans to use VMware's strong cash flows to pay down its heavy EMC-related debt load.

• Dell already owns 82% of VMware through its purchase of EMC. VMware's stock has vacillated wildly over the past few months on hopes of a full Dell buyout.

• While deal variables are still major unknowns, the company's performance is still strong and VMware trades at cheap multiples of FCF.

• Dell's Q4 results included an acceleration in license revenues to 20% y/y growth and a >70% growth in free cash flow.

As usual, the reaction of investors to the news is frenetic and almost always exaggerated. Last month, news that Dell (NASDAQ: DVMT) could buy VMware (NASDAQ: VMW) sent the latter's stock quickly to over $ 150. This decision was irrational because it was unlikely Dell would pay a big premium for VMware, of which 82% already belong to you.

On March 1, however, Michael Dell envisioned a "reverse merger" in VMware that would fully integrate the two companies and give it access to VMware's strong cash flow to pay its massive $ 50,000. With Trump's tax bill limiting the amount of interest that companies can deduct to 30% of EBITDA, Dell is competing against the clock to reduce its huge debt load (in the last twelve months, Dell has paid one incredible amount of interest: $ 2.542 billion, which puts you in great danger of losing the total tax deductibility on that interest.Your TTM EBITDA was only $ 3.852 billion - see my previous analysis here). In addition, VMware has approximately $ 7.5 billion in net cash ($ 11.7 billion in cash and $ 4.2 billion in debt) to address Dell's debt for the acquisition. EMC. .

As a majority-owned company owned by Dell and its majority shareholder Michael Dell, VMware and its board have little to say about what will happen. But, as usual, investors' reflex reaction to the deal is likely to be overexploited, and equities should rise again to between $ 120 and $ 130 as more details of the deal are known.