The Dell Effect

Dell's announcement that it was buying EMC will be the mega-merger to end all mega-mergers. How will it affect VMware, which thrived with the hands-off policy of its former bosses?

Several weeks after the announcement of the Tech Buyout Heard Round the World, Dell Inc. CEO Michael Dell posted a short blog item that could have been easily missed. In it, he made the following statement: "... we plan to handle VMware the same way as EMC by keeping VMware independent." That small declaration might seem inconsequential in the larger story of Dell's acquisition of EMC, but it went to the heart of what many consider the primary issue of how the purchase will ultimately affect VMware Inc.

"VMware is a crown jewel of the EMC federation," Dell also said in his statement. That is undoubtedly true, and it's shoved a question front and center: Will the jewel shine in its new setting, or become tarnished and fade? Will Dell's ownership help VMware thrive, be a non-factor or harm it in the long run?

The details are well-known by now: On Oct. 12, Dell announced a deal to buy EMC Corp. for $67 billion. The deal is expected to close next summer. Dell, having been taken private by Michael Dell in 2013, will take control of EMC and the various businesses in its "federation," which will also become private enterprises. But in a complex bit of financial maneuvering, VMware will continue to be a publicly traded company while still being owned by Dell.

Less Is More
It's a confusing jumble of circumstances, and no one knows at this point how everything will shake out, now or in the future. But the general opinion of the analyst community seems to be that Dell would do well to follow the example set by EMC after it bought VMware, and leave it alone.

Al Gillen, group vice president of Enterprise Infrastructure for IDC, says that "VMware is relatively insulated from the larger EMC business, and I didn't see then and I don't see now that VMware's business is directly affected by this acquisition, if and when it completes."

The transaction itself, Gillen says, could be a factor in Dell staying mostly out of VMware operations. "There's only so much you can do at one time, and it's going to be a pretty massive integration effort as it is, so mixing VMware into that whole integration and digestion process would be adding a whole lot of complexity that they don't need to have right now."

Stu Miniman, an analyst with Wikibon, says he has it on good authority that Dell has no plans to interfere with VMware. "Michael Dell has been very clear publicly that he's not going to mess with VMware. At Dell World, I got to personally talk to Michael [Dell's] son, and there's no indication that I have from anywhere that he wants to upset the apple cart."

In fact, argues Forrester Research Inc. Analyst Dave Bartoletti, it would be foolish for Dell to get involved in VMware's business. "I don't think Michael Dell will think he can tell VMware how to run a virtualization software business better than VMware knows how to run it. I think he'll feel that Dell is much stronger at building converged systems and in hardware engineering."

Should I Stay or Should I Go?
If Dell does leave VMware to operate on its own, is there a chance VMware is spun off, given it remains a hardware-focused company, and adding EMC does nothing to change that? "It could be within the realm of possibilities," IDC's Gillen says. "But as long as [VMware] is throwing off meaningful amounts of cash, and since Dell's a private company, with no active shareholders pushing for a divestiture, it really becomes a decision about short- and long-term value to Dell to have that asset in its portfolio."

Wikibon's Miniman doubts that VMware revenues are a crucial element in whether Dell sells off VMWare. "They've structured this in a way that the voting, the control, the influence is what they want. Dell throws off a lot of cash and EMC throws out a decent amount of cash. It's not the revenue in cash that VMware's going to throw off that they want. They've structured this whole deal to keep control of VMware."

Indeed, the majority of EMC's value comes from its ownership of VMware. There were even rumors in the past that VMware might consider buying EMC, instead of EMC dumping VMware. "[EMC CEO Joe] Tucci was always vehement that ‘there's no way I'm giving [VMware] up,' and I'm sure that Michael Dell would say the exact same thing," says Miniman.

Others aren't so sure. Dell is picking up a huge amount of debt to buy EMC, and it could be tempting to sell VMware to address that. "They could divest of the VMware shares, and that could be a financial (move) to pay down some of the cost of this debt," says Forrester's Bartoletti. But, he adds, "I don't think Michael Dell thinks he needs to do that, and VMware's results are going to be great for Dell/EMC's bottom line."

Outlook Cloudy
One of the lesser aspects of the deal wasn't discussed much in media reports about the acquisition, but could have a huge and fundamental impact on VMware: A new cloud services business has been created by combining the VMware hybrid cloud solution, vCloud Air, with Virtustream, a cloud company and Infrastructure-as-a-Service (IaaS) provider EMC bought last summer for $1.2 billion.

Cloud computing has been a primary focus of VMware's for years, as it seeks to broaden its revenue stream beyond compute virtualization, which still remains its cash cow. vCloud Air has carved out a place in the hybrid cloud -- a combination of public and private cloud infrastructures -- but not gained much traction in the "public cloud only" market dominated by Amazon Web Services Inc. (AWS) and Microsoft. Folding its technology in with Virtustream's capabilities could help VMware move more into that realm, along with its expansion into software-defined networking and software-defined datacenter technologies, both of which are critical to cloud environments.

"Virtustream has built a cloud offering that is targeting legacy applications; the big heavyweight things in your datacenter that don't necessarily run well in virtualized environments," explains Lydia Leong, a distinguished analyst at Gartner Inc. "Their flagship application is SAP, and they specialize in providing a cloud solution for SAP and other similar-scale applications."

Forrester's Bartoletti says that EMC's "Federation" structure -- a loose grouping of disparate companies under one roof -- has worked against it when it comes to the cloud. "VMware's cloud strategy has gone through several twists and turns over the years. Here's another place where the Federation sort of screws things up. VMware's building vCloud Air out, and EMC acquires Virtustream. Basically, the company's going into a holding pattern again, and the market's asking, ‘What is your strategy?' What Virtustream brings into the Federation is a very focused approach to public cloud that's around a particular set of workloads."

Virtustreaming Technology
Folding Virtustream into VMware may eliminate that confusion. The downside is that it could be the end of vCloud Air as a separate entity; speculation exists that VMware will want a single brand for its cloud offering, and vCloud Air, which hasn't reached the heights the company envisioned, will draw the short stick. Bartoletti puts it bluntly: "Virtustream has won over vCloud Air."

In the short term, Gartner's Leong thinks the move will cause some pain. "The merger into Virtustream is going to create lots of customer questions about the future state of vCloud Air, which is probably going to slow sales."

Miniman, however, could see things unfolding in a different way. "vCloud Air's been struggling a bit, so we'll see how this invigorates it," he says.

A ‘Cloud Supplier' Only
Could it also invigorate public cloud ambitions for Dell? At one time, the company wanted to be a public cloud player, but it got out of the game several years ago, deciding it couldn't compete with AWS and Microsoft, so it spent its research and development energies and money elsewhere. Now, with Virtustream and vCloud Air combining forces, is it possible that another entry into public cloud is on the horizon?

Miniman says that the boss himself said No. "At Dell World, I asked specifically about the Virtustream acquisition. Michael Dell said, ‘We're not going to make a public cloud; we are a supplier for the cloud.'"

Gillen sees it the same way: "I don't know that Dell needs to get into being a cloud provider. You've got the businesses within EMC; vCloud Air; the other efforts going on there that are cloud-oriented, so why does Dell need to bring that particular business -- the hosting business -- back into its portfolio? I don't think it's a likely scenario."

Leong says the competition would be the biggest impediment to Dell using Virtustream/vCloud Air to jump back into public cloud. "What circumstances would encourage them to go back into that business, now that Amazon is an almost $8 billion entity, Microsoft is $1 billion-plus, and both vendors are doing extremely well with a very rich and complex set of services, and are both serving the enterprise very well? What would Dell believe would allow it to compete in that space?"

Is that the last word, then? Maybe not, according to Bartoletti. "I think they're out, but look at the weird Federation, with Virtustream, which is a public cloud; so they're back in it," Bartoletti says.

The Partner Angle
Beyond the cloud, another important aspect of VMware's business likely to be impacted by the Dell purchase is its partner relationships. Dell and EMC have partnerships all over the map, and are more partner-friendly than VMware. The deal, Gillen says, "... gives Dell a nice set of technologies that they can integrate with their servers. But don't forget, Dell's always been very big in terms of a partnering organization. Dell's been very big with, for example, Microsoft; and Microsoft's not necessarily a big partner with VMware. Dell has partners in SUSE, Red Hat and Oracle, and all these companies see VMware as a competitor. VMware has very few allies in the industry, in terms of basic infrastructure vendors."

VMware has also been trying to move hyperconverged appliances into the datacenter, using its software-defined technologies. Although Dell is a significant VMware partner in this area now -- "Tons of Dell gear goes out the door with VMware on it already," says Bartoletti -- there could well be worries among other VMware partners that they could be shut out in favor of their new owners.

Would Dell cut out VMware's hyperconverged partners? "I don't think that would be a shocking development. Not at all," says Bartoletti. But, he adds: "I think it would be a mistake if Dell tried to unwrap VMware's software position within other converged platforms."

The Microsoft Angle
Of course, one of Dell's biggest, most important partners is Microsoft. And Microsoft competes directly with VMware in some core areas like compute virtualization. It's another relationship that gets a lot more complex with the deal.

"The Dell/Microsoft relationship is kind of interesting, which adds a weird wrinkle to the VMware relationship," Miniman says. "EMC's always worked with Microsoft, but after the VMware acquisition, there were a whole lot more people working on VMware-related stuff inside EMC than there were working on Microsoft stuff."

It's tricky for Dell, as well, Gillen says. "Let's take a scenario in which Dell decides to integrate VMware very heavily in its core business... What does that do to the relationships Dell has with all these other providers? I don't see any of that being good for Dell's relationships. Disrupting those relationships is not necessarily good for Dell in the long term."

The Crystal Ball
The deal is still many months from closing, and the reality is that no one knows exactly what the new Dell will look like after having absorbed such a massive company. Those interviewed for this story were asked if they think the deal ultimately will end up as a net positive, net negative or net neutral from VMware's point of view.

Leong says, "There are many different ways in which this could go. My guess is that on the entire balance, it will end up being perceived as neutral," for VMware.

Bartoletti says he has two predictions, depending on Dell's behavior toward VMware: "If Dell starts exerting muscle over VMware's product direction or product strategy, or tries to fold the company in to Dell, I think it would be a lose for VMware. If they maintain the current hands-off [management style], and keep it a financial-investment relationship, only: ‘We're only a majority shareholder, and let VMware continue to innovate on its own,' I think it will be positive for VMware."

"I don't think it's a negative [for VMware]; it's definitely not that," says Miniman. "I'm leaning toward neutral, but here's the underlying piece of it: We've been underestimating the role of hardware in some of these. Dell has a low-margin hardware business; they know how to create solutions that work for the service providers." Because of that, he says, "I give it a thumb up, but not two thumbs up."

Gillen believes that Dell is likely to have little impact at all on VMware. "If we're working on the assumption that VMware continues [to operate] as a standalone company, I don't think it's a win or a lose for VMware. Their business will be dependent on how they run their business."

Bartoletti likened the new relationship between Dell and VMware to a reconfigured family. "It's almost like mom just married a new guy. He might be a little more domineering, but your parents pretty much let you come and go as you want as it is; and you can get a ride to school from either your mom or your dad."


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