EMC – Cloud Nine?

It was Whitney Tilson’s interest in this stock (http://www.gurufocus.com/StockBuy.php?GuruName=Whitney+Tilson) that sparked my own. My initial screen is always owner earnings x 12.3, which gives provides a very approximate guestimate as to what the stock will yield as a 15 year ‘equity bond’ discounted to the net present value.

In the case of EMC I estimate owner earnings at $5,024m. To arrive at this figure I take operating earnings of $6,262bn and deduct capex of $1,238m (which includes the cash flow statement item of ‘Software Development Costs’ because of the nature of the business) then multiply by 12.3. This provides a rough valuation of $61,795m against a market cap of $52,000m, which indicates this stock may be selling at an approximate 20% discount to intrinsic value. Which prompts one to fire up the printer for the annual report…

EMC are betting the ranch that the corporate IT sector wades neck deep in to ‘cloud computing’ and embraces ‘big data’ analytics. Corporate IT departments are understandably cautious on both these fronts, as dropping the ball regarding the security and analysis of data can be front page news. Therefore the third leg of EMC’s strategy is ‘trust’.

A first glance at the numbers are encouraging. Revenues have increased by approx 1/3 over the last five years whilst net income has doubled. Gross profit margins are consistently in the region of 60% whilst net earnings margins hover around a respectable 13%. Return on equity was also 13% in 2012, but was as low as 7% as recently as 2009. Long term debt is negligible at just $58m. If one values the stock as an ‘equity bond’ (owner earnings / market cap) it yields a respectable 9.5%, and there is plenty of scope for growth in the near term.

So why not invest? Warren Buffett once said that he likes to shoot fish in a barrel….when the barrel is empty and the fish are dead. In the case of EMC there are a few live fish that worry me in the long term. EMC encapsulates the risk on p15 of their 2013 10-K; “There can be no assurance that our vision of enabling Cloud Computing, Big Data and Trust through infrastructure and application transformation will be accepted or validated in the marketplace”. There is a good chance that it will be, but in the world of IT there is always the concern that there is a college drop-out sat in a garage as we speak developing something that will fundamentally change the industry. There is too much uncertainty. Even if cloud and big data are embraced, there are some massive players competing in the market with EMC. Amazon has waded deeply in to cloud and IBM competes on both fronts. And as we know, if you are venturing in to a risky area in IT, the old adage is that “nobody gets fired buying IBM”.

Therefore I can’t see where this company will be in 10 years, and I have to pass.

The author holds no position in EMC.


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