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Slowdown could push VMware into storage market

It seems crazy, and in many ways it is. The company that essentially created the hottest market in IT has said it will grow 50% over the next year, and the company that owns it has projected $15 billion in revenues for 2008. And yet as of this morning, Company #1, VMware, has seen its stock drop 33%. Company #2, storage giant EMC, has seen its stock drop $1.02, to $15.89.

The problem, ESG analyst Brian Babineau points out, is that VMware grew 90% last year–it’s not that 50% growth is bad, it’s that 50% growth is relatively bad. “You’ll get the airbag on that stop,” is the expression I’ve heard used.

Meanwhile, the consensus is that EMC’s poor stock performance is a direct result of the VMware issue–even though EMC has achieved its goals of folding in a dizzying array of acquisitions, balancing its revenue streams across software, services and its core storage hardware business, and bringing its products up to speed with emerging technology trends. . .even getting out ahead of them with the first Tier 1 array, DMX-4, to support flash drives internally. “I don’t know that EMC’s business execution could have been much better,” is how Brian put it to me yesterday in my story on EMC’s earnings call.

And yet these companies both are in trouble on the stock market today, and more alarming is the underlying reason: a dramatic slowdown in revenue predicted for VMware. If this truly comes to pass, it could be the darkest omen yet in the chain-reaction brought about in the market by the subprime mortgage crisis, the culmination of fears about the tech market in general this year that began when Cisco revised predictions downward in November. The general vibe from the financial eggheads seems to be that if the highest-flying tech company on the market is forecasting a slowdown in spending, what’s next?

I’ll admit this scares me a little too. The way I understand it, greedy bankers gave loans to unqualified people, and then those shaky loans in turn were carved up into securities, meaning that when those unqualified debtors couldn’t manufacture money (lo and behold!) the whole house of cards started to tumble down. In a way, it’s satisfying to see the people who played on the dreams of low-income people to own homes by locking them into high-interest-rate deals, with no regard to how they were going to come up with the cash, get their comeuppance. But when it threatens the entire national economy, it’s hardly worth the last word.

But before I could step off the ledge into panic myself, this morning I had a chat with Andrew Reichman of Forrester Research, whose level-headed perspective is one I think will eventually shake out once the initial frenzy is over. Or, at least, I hope.

“This is typical of the financial world–overblown expectations,” he said. “I still see VMware’s product and outlook as very strong.” Even in a recession, Reichman pointed out, VMware still has a value proposition, since server virtualization is a consolidation and cost-cutting play. “They can still demonstrate to companies why they should spend money on their product even as they try to put the brakes on IT spending otherwise.”

Great point. Then there’s just the plain fact that 50% growth ain’t too shabby! Especially as the market braces for a spending slowdown–and especially when analysts say 60% of the market has already purchased and deployed VMware’s product. “It’s rare in the technology world to see such consensus around one piece of technology,” Reichman concurred. “They’ve built up a lot of momentum and there’s still a lot of room for them to take advantage of the ‘network effect’ and expand existing customers’ use of the product.”

However, Reichman had another suggestion about the VMware situation that piqued my interest, especially given my recent post on storage virtualization and VMware and the sometimes tense relationships between the two. “What they need to do to continue their growth is take the money they got in the IPO and they’ve built up in revenue and find the next frontier.”

Reichman’s prediction for that next frontier in the near future is business continuity/disaster recovery, which VMware has already said it’s working on. “There’s a high level of interest at a lot of companies in using VMware for BC/DR,” he said. But he added that the next horizon will probably be primary storage–or storage virtualization.

“The story of storage behind VMware has never been clear,” Reichman said. “There are a lot of issues that remain around storage virtualization, performance and compatibility and a lot of room to improve that picture.”

He continued, “They’ve played Switzerland for a long time. Now they need to get off the dime and make a call about how storage is going to work behind server virtualization.”

Of course, it’s hard to tell what the consequences of that might be. Other analysts such as the Burton Group’s Chris Wolf have pointed out that if hardware vendors don’t support VMware, end users won’t take the risk of using their product. But has VMware’s ascension into a Wall Street bellwether changed that equation? Has its ubiquity in IT shops turned the tables on the storage vendors–so that end users will instead be less inclined to use a storage technology if it’s not certified with VMware? How will this balance-of-power play out?

It’s like that expression about the old Chinese curse. We are living in interesting times.

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IBM is already doing storage virtualization with the SAN Volume Controller and in case you haven't noticed it works very well.
Kas, I don't think I denied that there are storage virtualization technologies already on the market or made any statement about whether or not they work. But there is also some tension / uncertainty about which features are going to be controlled by VMware's hypervisor and which are going to be controlled by the storage subsystem or storage virtualization device. My point is that as VMware grows hungry for new revenue streams, they may start to tug harder in that tug-of-war, where at this point, if they chose to do so, they'd have a leg up--regardless of SVC's merits as a technology, 60% of the market hasn't adopted it.
Citrix won't support Citrix VM's running on ESX only on their own Xenserver and now I'm hearing that Microsoft will not support SCCM on ESX but only on their own hyper-V. It's been too smooth of a ride for VMware - now comes the angry competition. Leave it to the vendors to refuse support even though it will work fine. Too bad VMware has not endeared itself to their customers - many are looking for a reason to jump ship.
Beth, Regarding your comment that the greedy bankers "played on the dreams of low-income people to own homes by locking them into high-interest-rate deals," nothing could be further from the truth. In fact for the past several years a substantially compressed interest rate spread between low-risk and high-risk loans. Mortage originators were giving loans out to poor-credit-quality buyers at rates the were competitive with high-credit-quality buyers. It was more like giving cheap candy to children with advanced tooth decay. Now the lenders, or the shareholders who bought the securitized instruments, are left with the dentist bills. Responsible lenders would have charged appropriately high rates for high-risk loans, decreasing the volume but increasing the effective yield.
Hey John, thanks for that clarification. I think I was considering mortgage originators "bankers" as well. Aren't they usually?