EMC Facing Difficult Challenges

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By Ross Schwartz on May 15, 2014 Consumer Staples

We were struck by the theme of redefinition at this year’s EMC World conference, which we believe is apt not only for the current IT landscape in general, but also for EMC in particular. The company is facing the difficult challenge of adapting to a secularly changing IT environment in which multiple forces are conspiring to transform the storage market, including workload movement to the cloud; the broad adoption of data-reduction technologies; the emergence of next-generation flash-centric arrays, software-defined storage, and converged infrastructure platforms; and the rise of opensource big data applications, such as Hadoop.

While CEO Joe Tucci believes that the impact of the cloud (specifically Amazon Web Services) on the storage market has been more psychological than concrete, the confluence of the above forces has had a clear disruptive impact on the storage market in terms of new competition, new delivery models, and broadly speaking, increased revenue and pricing pressure. We have seen the impact on both EMC storage revenue and gross margin over the past year, and we worry that these headwinds might accelerate. While EMC’s smorgasbord of products allows it to cover the gamut of IT workloads and its federation model allows the company to play both sides of the fence (on premise and cloud), the question at hand is whether EMC’s emerging platforms can grow fast enough to offset declines in the legacy platforms and rejuvenate growth in EMC’s storage business, which is still roughly 70% of overall EMC revenue.

Ultimately, we believe EMC will end up on the winner’s side of the war given its collection of assets and its proven ability to execute and be proactive from a technology standpoint; however, the next couple of years are likely to be a tricky transition period. As a result, we remain neutral on the stock. New product engine continues to run, for better or worse: EMC is maintaining its adherence to the philosophy that one size does not fit all in the storage market, showcasing its plethora of products that target different workloads in the enterprise and service provider markets. The company’s innovation engine is two-pronged: 1) roughly $3 billion is spent annually on R&D, which has led to new products, such as ViPR, and consistent updates to existing products, such as Data Domain and VMAX, and 2) roughly 10% of annual revenue, on average, is spent on acquisitions, which has enabled EMC to introduce cutting-edge technologies to address new workloads.

The latest acquisition, announced on Monday, was stealth-mode start-up DSSD, which is developing an ultra-low-latency flash array designed for IO-intensive workloads, such as Hadoop and in-memory databases. A core part of EMC’s product philosophy is to play offense when others are playing defense, and to remain unafraid of cannibalizing its own products. To this end, the company is making big bets that it expects to pay off—including ViPR, Pivotal, Nicira, AirWatch, DSSD, and XtremIO—and position it well for where the IT industry is going and when the pendulum swings back on IT spending. At the same time, the apparent challenge is that as the company keeps layering on new products without eliminating legacy products, at some point there will simply be too many products under the EMC storage umbrella, which will become confusing to salespeople, partners, and customers; it will also be expensive to support and maintain.