Get Your Head In The Clouds

Cloud computing is here to stay, there is no question about it. It affects almost everyone's lives, whether you use Google GOOG Docs, iTunes, Dropbox, movies, video games or any other type of content. It is the single largest computing trend of the past 20 years, as consumers want access to their documents everywhere on any number of devices, and at the forefront of this technology is a little tiny company names VMware VMW. Maybe you've heard of it. Last night, the company reported strong earnings that blew past Wall Street estimates, but the company gave somewhat conservative guidance that many on the street are looking at a sand-bag guidance, similar to what Apple AAPL does. The company reported second quarter earnings of 55 cents per share on $921 million in revenues, beating handily Wall Street estimates. Wall Street was expecting earnings of 47 cents per share on $872.96 million in revenues. The company said it expects third quarter revenues to be $915-$940 million, versus the estimates of $898.75 million. Some banks, such as Wunderlich Securities believe that VMware is being extremely conservative with their guidance for a few reasons, most of the maco kind. In a research note, Wunderlich wrote, "We believe investors will be mixed in their assessment of 3Q guidance, with some pointing to recent upside as evidence it is conservative, and others pointing to macro and company-specific factors that suggest warranted concern." "VMware's second quarter results were driven by strength across geographies and record enterprise license agreement bookings as a percentage of total bookings," said Mark Peek, chief financial officer. "Third quarter 2011 revenues are expected to be in the range of $915 and $940 million, a year-over-year increase of 28% to 32%. The third quarter non-GAAP operating margin is expected to decline sequentially by 260 to 360 basis points. For the year, we expect annual revenues to be in the range of $3.65 billion and $3.75 billion, an increase of 28% to 31% compared to 2010." Shares are up ~2% today as the broader markets are giving back some of yesterday's gains, but the real trend here is strong sustained growth for VMware during coming years. As the undisputed leader in a space that is going to grow like a weed for the foreseeable future, VMware has seen its share price rise drastically over the past few years. Still majority owned by EMC Corporation EMC, VMware shares have risen over 200% in the past two years, and with revenues growing 30% year-over-year, VMware will benefit from the tremendous inflows in cloud computing. Valuation, shares are obviously not cheap, trading at 46 times forward earnings, but investors are certainly willing to pay for the growth that VMware is offering. With a market cap of $45 billion, the company is 75% the size of the company that owns 80% of it, and it looks like there is no stopping it, at least based on its past. The company does have competitors in the space obviously, but names like Citrix CTXS, Microsoft MSFT, IBM IBM are either not as focused on the cloud computing space as VMware, or simply put, not as dominant a player. Maybe investors need to get their heads out of the sand and into the clouds after results like this. ACTION ITEMS:

Bullish:
Traders who believe that VMware will continue to grow sharply over the coming years might want to consider the following trades:

• Go long EMC EMC which owns 80% of VMware, and is more reasonably priced on valuation metrics.

• Why beat around the bush? Consider adding to a position in VMware. With a company growing revenues over 30% year-over-year, there is likely to be a bump or two in the road, but in the long run, the company should continue to generate strong growth.

Bearish:
Traders who believe that VMware is going to lose market share in cloud computing may consider alternate positions:

• IBM IBM has said it wants to make cloud computing a focal point of its growth plan, and IBM generally purchases its growth.

• A name like Citrix or Fortinet FTNT could be potential acquisition targets for IBM.

Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.