Description

Note the financials are for VMW since that is what matters as DVMT is just a tracker. 

Here is the quick exec summary for those who are too busy with Turkey-comas and College Football.  

What: DVMT is a tracking stock for VMW - it currently trades at a 35% discount to what it tracks

Why: DVMT is an unsecured creditor of Dell (Dell is levered, certain rights are stripped, etc.)

Return: Overtime two things will happen: first, DVMT will collapse the discount from its current level to some lower level (for my analysis I assume it shrinks to 20% but I can make a cogent argument of why it should be even less) and second VMW itself will appreciate as the market realizes it has a future.  Right now you can purchase DVMT for something like 6x 2018 FCF. This should combine for an overall return of something like 50% over the next 12 months.  This could be a near double if the discount collapses to zero (which is possible).

Some sardines are made for trading, others are made for eating, DVMT is an eating sardine.  

Buggs1815 did a good job of writing DVMT before it was issued in September of this year.  I hope to expand on this write up by focusing more on how VMW itself will juice the returns.  

VMW:

The bear case against VMW was simply this: cloud, cloud, cloud, cloud.  VMW made their mint virtualizing machines within private clouds to allow enterprises to stretch resources (i.e. save money).  This has slowly changed as public clouds like AWS and Azure have taken off as compute has moved from private to public cloud.  Many thought this was the death blow for vmw what they failed to realize was the there is a long fat tail in the transition to the public cloud and some customers may never fully move there (think financials and healthcare).  Further VMW has not been sitting idle and has been innovating on ways to further extend their useful lives.  This is best exemplified with the IBM and AWS partnerships.  The AWS partnership is far more important than the IBM partnership (spoiler alert AWS has a brighter future than IBM).  The AWS partnership allows companies to utilize the elastic compute capabilities of AWS while remaining safe within the VMW vSphere set up.  In simple terms this basically means that VMW acts as a critical stepping stone for companies who want to partially transition or just take advantage of public cloud resources while not giving up the comfort blanket of the VMW private cloud.  AWS is going into beta testing in Q1, there is a chance they talk about it at reInvent (AWS conference in Vegas next week).  Further it will go live in 2H'17.  I have spoken with a couple channel partners on this and they are very eager since it helps open up a new class of customers and more cross selling opportunities.  

VMW has four key products worth talking about (some others but realistically they are just noise):

1) vSphere - this is VMW's main virtualization product that allows you to run multiple virtual machines on a single piece of hardware

2)  End user computing - this is their mobility management product (basically the bones of the AirWatch acquisition with some desktop virtualization sprinkled on top)

3) NSX - this is VMW's sexy new product, it is a network virtualization product.  Many customers are using it for micro-segmentation and it allows networking hardware to become more efficient (think of vSphere but for firewalls, switches, and routers).  

4) vSAN - This is their new virtualized storage product (integrated into vSphere kernel which pools disk space) - this product competes with NTNX 

Product category #1 is in a long-term secular decline.  It was originally predicted to decline at a rapid rate but many are now realizing it will be a slow bleed (has slowed from -30%+ declines to now a low single digit decline).  Product #2 will never amount to much and I wish they would stop devoting resources to it (luckily its not a huge resource sink).  Product categories #3 and #4 are fast growers.  The biggest issue VMW has is all products tend to be bundled so they don't really break out the desired amount of disclosure.  On calls they will talk you through how each product category is doing (as an FYI this makes for a really annoying exercise when you are piecing together the last five years of quarterly information), but I digress.  

Of late VMW has been using excess cash flow to repurchase stock.  They have spent $1B in Q3 and are committed to purchasing more in future quarters.  When I met with management they said stock purchases will continue to be a prime use of cash however they will eventually have to stop repurchasing DVMT stock once they shrink the float such that Dell owns 90%.  At this point they will likely move to dividends.  As part of the EMC acquisition, Dell committed to providing $1B in revenue synergies.  I think this is highly achievable and to be honest could actually undershoot.  In speaking with a number of channel partners this was viewed as a no brainer (also a threat to NTNX but that is a story for another time). 

Dell Transaction:

Dell acquired EMC which had a 81% ownership in VMW.  ~35% of the ownership was retained with the Dell Holdings Co. while 65% was spun out to the public via DVMT.  As mentioned DVMT is an unsecured creditor to Dell.  On a pro-forma basis Dell is levered at 5x-6x net debt /EBITDA and is rapidly deleveraging and should be at 3x by the end of next year.  As mentioned in the prior write-up the dividends may not flow to DVMT, there is a common stock committee appointed to ensure the rights of DVMT but there are some loopholes (replacing securities of equal value, conversion into Class C Dell Holdings shares upon an IPO, etc.).

Here is what you do need to believe and I think this point many people gloss over.  Michael Dell didn't exactly leave the public markets with a good taste in their mouth.  Given he would one day like to IPO again (if not I am confused how he convinced Silver Lake to join him in the LBO) he needs the public market to be welcoming with open arms.  As a result DVMT is his single most direct way to re-build goodwill amongst public shareholders.  As a result I think he will put DVMT shareholders on a silver platter.  This is not to say he wants to give away money but I do think this tracker's sole existence was to help fund a large buyout at a discounted price.  It is in Dell's interest to work to collapse the discount since it makes their 35% retained ownership in VMW worth that much more.  Think about it, VMW has a $35B market cap, Dell owns a 35% direct interest in VMW - this is worth ~$12B but this $12B trades at a 35% discount so if Dell can collapse this discount it creates ~$4B out of thin air.  I guess this brings up the classic efficient market debate if you see $4B sitting on the sidewalk do you bend over and pick it up?

Risks:

1) The move to public cloud accelerates as banks and healthcare companies all of a sudden become comfortable with public cloud exposure

2) Dell finds another way to screw public shareholders and officially becomes the Ron Perlman of the tech world

3) Dell goes BK and DVMT shareholders are in trouble (extremely unlikely given how much cash Dell throws off - look at where debt trades and the discussion on deleveraging)

4) VMW invests in some stupid product (luckily the past has shown this to not be the case)

Summary:

The key beliefs you need to have to get excited on VMW are as follows:

1) The transition to the public cloud will be subject to a fat tail where many customers are fast adopters and others slowly migrate over.  As frame of reference VMW currently has 100% of the Fortune 100 using their software .  For my model I have vSphere billings declining 20% YoY versus an average of -13% YTD (note the decline has been tapering off)

2)  AWS & IBM partnerships will help cement VMW's relevancy

3) VMW's new products (vSan and NSX) will continue to grow which will add to topline growth

4) Dell will deliver on its $1B in revenue synergy promise

All this translates into double digit growth this year (mainly due to ELA renewals) and high single digits in the next couple years.  This allows you to purchase VMW at ~10x 2018 TEV/FCF but when you apply the 35% DVMT discount you can purchase VMW at ~6x 2018 TEV/FCF.  ~10x TEV/FCF is too cheap and VMW will probably march upwards to around $100 per share.  DVMT similarly will also march upward but will also have the added benefit of a shrinking discount. Tracking stocks typically trade at some discount - the sample set is really small (mainly Malone entities) which is around 8%.  But I think given the sour taste Dell left folks with 20% seems fair.  As a result I can get to a ~50% return.  This would be juiced to 90% if you think the discount eventually collapses to zero (which it could in a full spin or full repurchase in).  

So net-net you have a chance to buy a growing company at a cheap multiple made even cheaper by a temporary discount due to added complexity.  While it is tempting to just play the collapse in the VMW/DVMT discount there is more return to be made.  As mentioned this is a tasty eating sardine. 

Catalyst

The path to profitability will be accelerated by:

1) Continued VMW performance and buybacks

2) Dell deleveraging and using cash flow to repurchase DVMT shares (incredible accretive for them to do so)

3) AWS partnership launching in 2H'17 

4) Dell delivering on $1B revenue synergies