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Activist Elliott Pushes EMC to Dump VMware

The tech M&A chessboard is going to get very complicated.

World Economic Forum / Remy Steinegger / Creative Commons

The activist investment firm Elliott Management pounced on storage and technology giant EMC today in a lengthy letter urging it to divest its controlling stake in the cloud software firm VMware.

The two companies are holding each other back, the letter said, and cites several examples where the two outfits, ostensibly part of the same company, effectively compete against each other — with the result that EMC shares have underperformed compared to its peers (companies like Hewlett-Packard, IBM, Cisco Systems and Intel) and the wider markets.

The firm, controlled by the billionaire Paul Singer (pictured), controls more than two percent of EMC’s shares, and started its campaign to force its breakup in July. But this latest sally comes just days after HP announced its big breakup plan.

Recall that Hewlett-Packard, before announcing its plan to split in two earlier this week, had been in advanced discussions with EMC about a potential merger.

To the Letter

The Elliott Management letter is also critical of EMC’s one-of-a-kind “federation” structure. Essentially, EMC’s CEO, Joe Tucci, has assembled a “company of companies” comprised of the data storage business known as EMC2, VMware, the data security company RSA, and the newest bit, the big data analytics company Pivotal. Further muddying the picture is the fact that at least two of these companies are partially owned by outside companies: Cisco Systems owns five percent of VMware, and General Electric owns 10 percent of Pivotal.

Here’s the graphic illustrating the structure.

Source: Elliott Management

The main thrust of Elliott’s argument is that EMC’s main business is undervalued, and that a big part of VMware’s market capitalization comes from the VMware stake. It’s not worth as much as its closest rival, NetApp, which trades at a higher premium.

Worse, Elliott argues that VMware, long devoted almost solely to virtualization software that allows one computer to act like many, has branched off into several other businesses that compete with those of its parent. Having conquered the virtualization software market, it went after the next logical choice: Virtualizing storage. Naturally it was a ticklish move because it’s owned by a storage company with which it now competes, sometimes directly.

“Today, [EMC2] and VMware are completely at odds. In fact, we have heard from many in the industry (including former EMC and VMware employees) that they would have been at odds long ago but that VMware was slow to enter the storage market because it was owned by a storage hardware company. Regardless, they are now competing, a fact that EMC management concedes,” the letter reads.

Tucci has said publicly that he likes the structure and likes the fact that EMC and VMware compete. The point, he has argued, is that it creates a “no seams” structure, meaning it leaves no room for an upstart competitor to squeeze through. (One might want to ask Scott Deitzen at Pure Storage about that, but I digress.)

The HP Wrinkle

In an HP-EMC merger scenario, there is no way that the personal computer and printing business would be appealing to EMC shareholders. Margins are low, sales are declining, and both are essentially commodity businesses that throw off a lot of cash, but which are seen to be on a long-term decline. Now that those assets are due to be spun into a separate company called HP Inc. by this time next year, the remaining HP business, to be called Hewlett-Packard Enterprise, would be free to pursue a merger with EMC.

In fact, David Faber of CNBC reported this morning that talks of exactly that nature are still under way. We speculated about the possibility Sunday. It’s further worth noting that during Monday’s conference call explaining HP’s breakup, its CFO Cathie Lesjak said the magic words “material non-public information” in explaining why it had again paused buying back its shares, essentially telegraphing that further M&A activity is under serious consideration.

EMC shares are barely moving. They rose 14 cents to $28.28 or less than one percent after the letter was published. VMware shares rose 36 cents to $91.78.

Get ready for an interesting and complicated M&A ride.

Here’s the Elliott letter in full.

Elliott – EMC Letter

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