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What does the EMC-Dell deal mean for VMware investors?

Are VMware shareholders drawing the short straw with the introduction of tracking stocks?

EMC’s complex ecosystem of businesses turns what would otherwise be a straightforward acquisition into one of the most intricate deals in recent memory. At the moment, the biggest loser seems to be VMware investors.

EMC owns around 81% of VMware, which is a publically traded company in its own right; and with that, it controls roughly 97% of the votes. Dell is giving 65% of VMware back to EMC's shareholders in the form of tracking stock. With Dell leveraged up to its eyeballs, the tracking stock allows the firm to finance the deal without needing to generate additional cash.

The tracking stock will be a publicly registered share of common stock and will be based on the performance of VMware, rather than its parent companies. So far, so good? Not so fast. Tracking shares do not have the same rights as normal shares, the majority of which will be owned by Mr. Dell and his private backers. Most importantly, the tracking stock won’t have voting rights, meaning Dell will retain operational control of VMware, despite its (his) diluted ownership.

Tracking stock was used a lot during the tech boom but doesn’t feature too heavily on Wall Street these days. It is generally seen as a less attractive investment, as shares often trade below the standard price. Combine this with weaker voting rights and the fact that the parent company holds all of the assets, and it’s easy to see why investors might be aggravated by the proposition.

Analysts are also concerned that climbing into bed with Dell might damage VMware’s healthy partner ecosystem. The virtualisation giant has done a great job over the years at carving out relationships with a broad spectrum of vendors, many of which will be touting their technology at VMworld Europe this week.

The now-Galactic Federation is claiming that VMware’s new master will introduce $1bn in annual ‘revenue synergies’, however critics are not convinced. Because VMware’s virtualisation technology has always been relatively hardware agnostic, there are concerns that both vendors and customers might look elsewhere, rather than having the Dell portfolio shoved down their throats.

The net result of all these concerns? VMware stock has fallen 15% since the potential deal was first reported last week. This morning, Pat Gelsinger took to the airwaves to put a floor under investors’ concerns.

The CEO said that increased liquidity introduced by the tracking stock would ultimately be a positive for the company.

“Obviously with a deal of this magnitude, there is volatility around it, and the idea of a tracking stock, there’s questions around how that will work,” Gelsinger said on CNBC. “But ultimately, the increased liquidity of VMware in the marketplace will be a very good thing, allowing us to attract a much broader set of shareholders over time. We believe, ultimately, it will be a very good thing for the market, for VMware, for our employees and for our customers.”

In related news, VMware updated its preliminary financial results for the third quarter of 2015.

Revenues are expected to be $1.672bn, a 10% increase YoY, or 14% in constant currency. Non-GAAP net income is expected to be $1.02 per share. Despite both of the headline figures beating analysts’ expectations, VMware’s price fell as much as 10% following the news.



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