VMware, Microsoft and Other Software Giants Are Growing in a Cloud-Heavy World

 | Aug 15, 2017 | 11:32 PM EDT
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

vmw

,

msft

,

orcl

,

sap

,

adbe

,

adsk

,

ibm

,

hpe

,

csco

,

crm

,

wday

,

rht

Over the past 12 to 18 months, an interesting split has opened up in the performance of enterprise IT giants: While companies depending heavily on hardware and IT services revenue streams have often struggled to deliver positive sales growth, several of their software-focused peers have fared much better.

The divide says a lot about how the adoption of cloud apps and infrastructure services has been a tsunami that certain types of old-guard enterprise IT firms are much better-equipped to handle than others. And also the degree to which IT spending, whether in the cloud or elsewhere, continues shifting toward software relative to hardware.

Virtualization software giant VMware Inc.  (VMW) served up the latest evidence of this split on Tuesday, when it issued its second full-year guidance hike in less than three months. VMware now expects fiscal 2018 (ends in January 2018) total revenue and license revenue to each rise 10%, better than prior guidance for 7% and 6% growth. The company also hiked its July quarter guidance, estimating total revenue grew 11.9% to 12.6% and license revenue 12.9% to 14.4%.

Things looked very different in the first quarter of 2016. Then, VMware's license revenue (drives future maintenance revenue) fell 1% annually due to weak demand for its mainstay vSphere server virtualization platform amid growing use of cloud infrastructures relying on non-VMware virtualization software. Total revenue, propped up by maintenance contracts for past license deals, grew a modest 5%.

Today, enterprise vSphere sales are still under pressure. But VMware is offsetting this with strong growth for its NSX network virtualization and vSAN storage virtualization platforms, as well as healthy demand for its PC virtualization and enterprise mobility software offerings. The company is also getting a boost from software sales to cloud service providers that are part of its vCloud Air Network ecosystem, and -- though it's still early -- claims it's seeing strong interest for a managed cloud service it's launching for companies looking to run vSphere workloads in both their own data centers and on Amazon Web Services (AWS).

Microsoft Corp.  (MSFT) has seen its top-line growth improved markedly in recent quarters as well. After excluding the impact of the LinkedIn acquisition, the company's total GAAP revenue rose 8% in the June quarter, a sharp contrast to the 9% decline seen in fiscal 2016 (ended in June 2016).

Admittedly, Microsoft's fiscal 2016 performance wasn't that bad after one accounts for the impact of Windows 10 revenue deferrals and a nosediving phone business that's no longer a priority, but there has nonetheless been a big pickup in growth rates for the company's enterprise-facing businesses. Surging Azure public cloud revenue is helping, as is strong Office 365 uptake and healthy demand for products such as Windows Server, Dynamics 365 (cloud business apps) and SQL Server (databases).

Oracle Corp. (ORCL) , meanwhile, has begun delivering meaningful revenue growth after many quarters of struggling to do so as its on-premise business app and database sales slumped due to cloud adoption. Larry Ellison's firm expects revenue to be up 4% to 6% in its August quarter, a turnaround from the 3% decline recorded in fiscal 2016 (ended in May 2016). Oracle's acquisition of cloud business app vendor NetSuite is helping, but so is strong organic growth for several cloud product lines.

Oracle archrival SAP SE (SAP)  has had little trouble growing its top line in recent years, thanks to rising cloud app sales and growing adoption of the company's Hana in-memory database. SAP's total revenue grew 10% in Q2 with the help of 29% cloud revenue growth, and is forecast to rise 6% to 7% during the whole of 2017.

For their parts, Adobe Systems Inc. (ADBE)  and Autodesk Inc. (ADSK) are growing as they continue successfully transitioning customers from up-front software license sales to subscriptions that cover PC, cloud and mobile apps. Adobe's revenue rose 26% in its May quarter with the help of a 34% increase in annualized recurring revenue (ARR) for its core Digital Media business. Autodesk's annual revenue, though having dropped by about $500 million over the past couple of years due to the short-term impact of its business model change, is expected on average by analysts to grow by over $1.2 billion from fiscal 2018 (ends in January 2018) to fiscal 2020.

By contrast, IT giants such as IBM Corp. (IBM) , HP Enterprise Co.  (HPE) and Cisco Systems Inc.  (CSCO) are struggling to keep hardware growth positive, partly because cloud giants are on the whole much less enthusiastic about using their hardware than Global 2000 enterprises.

IBM's Systems division revenue fell 10% in Q2 and 18% in 2016 (mainframe cyclicality played some role, but wasn't the only factor. HPE's Enterprise Group -- it provides IT hardware and related services -- saw revenue drop 13% in the April quarter. While Cisco has seen good software and security growth, its Switching and Data Center (server) segments each posted 4% product sales declines over the company's past three reported quarters.

What accounts for the difference? There are a few factors at work.

    1. While enterprises are often replacing their purchases of on-premise IT hardware with cloud services relying on commodity hardware made by Asian contract manufacturers, they're replacing purchases of on-premise software licenses with cloud subscriptions that often -- though not always, as Salesforce.com Inc. (CRM) and Workday Inc.  (WDAY) will tell you -- come from the same software firms. And while these subscriptions produce less revenue over the short-term, the numbers posted by Microsoft, Adobe and others show they can produce more over the long run as more apps and services get added to packages.
    2. Total IT software spend is growing much faster than hardware spend. Gartner forecasts enterprise software spending will rise 8.6% in 2017 to $326 billion, while spending on "data center systems" will grow just 1.2% to $170 billion (on-premise spending growth will be negative). That's giving older software firms room to grow as businesses embrace not only cloud apps, but also products such as SAP's Hana, VMware's NSX and vSAN and Red Hat Inc.'s (RHT)  operating systems and middleware.
    3. Overall, companies with a strong software focus are seeing better software sales growth than more diversified firms selling some mixture of hardware, software and services. IBM's big Cognitive Solutions software unit saw revenue drop 2.5% in Q2. HPE's Software unit, much of which is set to be spun off and merged with British software firm Micro Focus, posted an 11% April quarter revenue drop.

Markets certainly aren't oblivious to how many software-focused enterprise IT firms have been executing, as a look at the performance of their shares since early 2016 demonstrates. But given the underlying trends lifting them, some of these names might still have room to run if markets stay favorable and the companies continue executing well.

Columnist Conversations

As far as TSLA is concerned, I still have a higher target above the market at the 409 area.  I stated in ...
The TLT setup discussed in my last commentary is a bust. Key support was violated and it violated the recent l...
BBY is getting smoked this mornings(weak forecast).  The stock is off 8% after opening the session with a...

BEST IDEAS

REAL MONEY'S BEST IDEAS

News Breaks

Powered by

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.