VMware Defies Competitive Pressures in the Datacenter 

The server virtualization gravy train just keeps rolling for VMware. Despite ongoing and large investments in research and development, the company has been able to grow its net income considerably faster than it is growing revenues. This is a sure sign that VMware has become an established player in the datacenter that enterprises have come to depend on.

In the third quarter ended in September, VMware had software license sales of $564 million, up 14.9 percent, and software maintenance fees rose an even faster 16.9 percent to $644 million. VMware is shifting more of its professional services business to partners, and thus this business declined by 12 percent to $81 million. Add it all up, and VMware brought in $1.29 billion in sales.

The cost of delivering that software is very small – only $51 million in the third quarter, if you can believe it – but to take on its many competitors in the virtualization and cloud controller markets, VMware has to spend big bucks on R&D as well as sales and marketing. In the third quarter, the company spent $266 million on R&D, which is 20.6 percent of revenues and quite high by even the standards of aggressive software companies. VMware spent another $449 million on sales and marketing, which is 34.8 percent of revenues. Even with these and other costs, VMware was able to bring $261 million to the bottom line, an increase of 66.2 percent compared to 2012's third quarter.

We know VMware is doing well at the moment and is managing to keep Microsoft's System Center and Hyper-V at bay – as well as numerous open source virtualization and cloud tools. But what we don't know is the revenue and profit breakdown by product category at the company. VMware only gives hints about what its 500,000 customers, who have more than 40 million virtual machines running atop the ESXi hypervisor, are buying.

In a conference call with Wall Street analysts going over the numbers, Carl Eschenbach, VMware's president and chief operating officer, said VMware closed the largest enterprise license agreement (ELA) in its history during the quarter, in this case with the US Army. This deal was a consolidation of multiple license agreements from several Army facilities that has been in the works for the past several quarters. Thanks to that deal. VMware's US Federal business was up in the quarter. Eschenbach said that around 33 percent of total bookings in the quarter were for ELAs and that this was the second-highest quarter for ELA renewals in the company's history. VMware closed five deals that were worth more than $10 million,

By product, sales of vCloud Suite, the bundle of virtualization and cloud management tools to create private clouds, beat expectations in the quarter, and Eschenbach said that the vSphere with Operations Management bundle, which sits halfway between plain vanilla server virtualization management and full-on cloud orchestration, also sold better than plan.

The company's hybrid cloud business more than doubled year-on-year. This portion of VMware includes sales of software to its service provider partners who are running their own VMware clouds as well as sales of capacity on VMware's own vCloud Hybrid Service public cloud, which was launched in May and became generally available in August. As EnterpriseTech has previously reported, VMware has just extended its vCHS datacenter capacity in the United States and is expanding into the United Kingdom to serve Western European customers.

Looking ahead, Jonathan Chadwick, chief financial officer at VMware, said that the company was on track to grow license revenues by between 8 and 9 percent for the full year, with the midpoint of the range hitting $2.27 billion. Total sales will grow between 12 and 13 percent and will be on the order of $5.19 billion at the midpoint of that range. Chadwick said that looking ahead to 2014, VMware thinks that it is possible to grow overall sales by 15 percent.

VMware is not worried about the fact that, depending on who you ask, that anywhere from 70 to 75 percent of the workloads in enterprise data centers that could have been virtualized have been. For one thing, Eschenbach explained, the remaining workloads are even more mission critical than the ones that have already been virtualized. And VMware has created tools to virtualize storage and networking and manage it all seamless as a "software defined data center," as the company calls it, and work its way across and up the IT stack, embedding itself deeper into datacenters.

This strategy has worked as VMware has transitioned from selling its ESXi hypervisor and vSphere and vCenter management tools to the vCloud Suite, the latter of which has an average selling price that is three times higher according to Eschenbach.

The way VMware sees the world, virtualization of servers will represent a total addressable market of around $6 billion by 2016, and it is growing at a compound annual growth rate of 10 percent or so. This is still a very good business for VMware, obviously. The larger software-defined data center market, which represents another $28 billion opportunity as storage and networking are virtualized and brought under control by VMware tools, is growing twice as fast at a 20 percent compound annual growth rate. The opportunity for hybrid clouds, which give public cloud access to private cloud customers, is a $14 billion opportunity and it is growing at 30 percent, according to VMware's estimates. End user computing, which is one of the other pillars of the VMware business and which means selling tools to virtualize PCs and tablets and smartphones in many different ways, is an $8 billion opportunity by 2016 and is growing at 20 percent.

These growth rates for these adjacent businesses are why VMware thinks it can accelerate its revenues in 2015 and beyond.