Spinning out VMware could give Dell long-term problems

Recent reports of Dell exploring the possibility of spinning off VMware as a separate company confound some analysts who believe the move would put it at a strategic competitive disadvantage.

Dell is exploring other options besides a clean break with VMware, including buying the remaining 19% of VMware or selling those shares to a third party, according to The Wall Street Journal, which cited unnamed sources. But spinning off the virtualization company entirely would largely sacrifice any advantage Dell might have in a world that is rapidly adopting hybrid clouds, virtualization and containers.

"People are going to the cloud more rapidly than expected," said Dana Gardner, principal analyst at Interarbor Solutions LLC in Gilbert, N.H. "So, this would be all the more reason to keep your best assets close together, making the whole greater than the sum of its parts. Future growth is in clouds and containers, not server hardware," he said.

What makes the timing of the announcement peculiar is that Dell and VMware are both doing well financially. VMware has freely pursued outside relationships, including major deals with AWS and Google, that haven't introduced any competitive friction for Dell. Dell has continued to share the lead with HPE for server market share, according to IDC's latest report, and has put some distance between itself and IBM and Lenovo.

Gary Chen

Last month Dell reported revenue of $21.9 billion, up 1.7%, which beat analysts' estimates of $20.8 billion. VMware's first fiscal quarter saw revenue rise 12% to $2.73 billion, compared to last year's fiscal first quarter. Company officials cited its SaaS revenues, which grew 39% to $572 million, as a major reason for the increase.

It's a mutually agreeable state of affairs that has some analysts surprised over talk of a potential split.

"Their products don't compete against each other in any way, they have worked it out so they fit nicely together," said Gary Chen, research director of IDC's software defined compute practice. "From a strategic point of view, I don't necessarily see a compelling reason to do it or not do it," he said.

This [spinoff] would be all the more reason to keep your best assets close together, making the whole greater than the sum of its parts. Future growth is in clouds and containers, not server hardware.

The coronavirus has indirectly made it clear that VMware's portfolio is more strategically important to Dell in that it has pushed corporate accounts toward hybrid and multi-cloud cloud adoption, which has taken away from server hardware sales, Interarbor's Gardner said.

But if VMware became completely independent, it might give the company incentive to pursue a similar relationship with a competitor of Dell's, not just among hardware vendors but cloud vendors as well.

"It could chase VMware into the arms of an IBM or Google, companies they already have comfortable relationships with," Gardner said. "That could prove to be more competition Dell has to fight off," Gardner said.

But another analyst said Dell would also be free to pursue relationships with other hybrid and public cloud companies, which in turn would allow them to better compete with their traditional server hardware rivals.

"It enables Dell to peacefully coexist with [Red Hat's] OpenShift and RHEL and Microsoft Azure," said Geoff Woollacott, senior strategy consultant and principal analyst at Technology Business Research.

"They could better compete with HPE and Lenovo to provide the underlying infrastructure for top-tier cloud players, or even align with IBM with a go-to-market strategy combining its Intel-based servers with IBM's higher-end servers for solutions aimed at edge computing," he said.

Dana Gardner

IBM has also made open source an emphasis of its strategy through the acquisition of Red Hat, and Microsoft continues to add support for Linux. Dell could see value in expanding relationships with these increasingly open source-friendly vendors.

Whatever way Dell decides to go, it wouldn't be going there soon. The most likely timing for a decision would be no sooner than September 2021, when Dell could make the move and avoid the associated taxes.

Otherwise, Dell would be forced to pay hefty taxes to spin VMware off before September 2021 because federal guidelines state each company must continuously operate for five years to avoid such taxes.