Prices of well-managed companies do go on sale and it’s the duty of the value-oriented investor to pick among them. Indeed, plummeting prices can often be opportunities, but some aren’t. This last week offers VMWare Inc. (VMW, Financial), a $36 billion technology powerhouse that generates more than $6 billion in revenues. Earnings grew 15% y-o-y and beat expectations by a penny —Â $1.08 vs. $1.07. The company has a rock solid A+ balance sheet (less than 20 % debt to equity and less than 9% to assets). Management has lots of opportunities and flexibility as discussed below. Valueline’s quick snapshot:
First a quick overview: VMware, Inc. provides virtualization infrastructure solutions. Since some investors won’t know exactly what that means, think of it as a cost efficient way to manage and grow the data requirements of an organization. VMW’s solutions include a suite of products designed to deliver a software-based data center that operates on standard computers and servers across a wide range of operating systems (think MSFT, Linux, OS, etc). VMW allows its users to enable multiple servers into data storage and networks that become shared pools of capacity. Why is this important? From a layman’s perspective, if you’ve had your PC crash because your hard-disk got too full then lost a day’s productivity trying to retrieve and get back to working, extrapolate the magnitude of the risk across large enterprises.
The power and scalability of VMW’s services was advanced last week with Google (GOOGL) and a partnership to compete against Amazon.com (AMZN) and others for enterprise clients for cloud based computing needs. Investor’s Business Daily covered the news release here: http://news.investors.com/012915-736941-vmw-goog-integrate-public-cloud-technologies.htm?ven=yahoocp&src=aurlled&ven=yahoo
But a quick chart lookup will reveal VMW crashing last week. What happened... I just described top line revenue growth and earnings beat? Simply, some analysts wanted higher future expectations. And with that gift (aka irrational response), the equity drops nearly 10% to 52 week lows $73.65, a nadir not seen since 2010 when earnings and revenues were a pittance of today. Then, revenues were ‘only’ $2.6 billion and earnings were $0.84 cents per share versus 2014’s $6+ billion revenue and $3.32 earnings.
If that rationale fails to square with you, you’re in good company with management, demonstrating a shareholder centric view, VMW committed another $1 billion to buy back its Class A common stock through the end of 2017. Importantly, this is in addition to its ongoing $1 billion buyback plan announced in August 2014. And more importantly, it appears management has yet to pull the trigger as 430 million shares remain outstanding since 2013. I’ll opine, without a dividend, this buyback will provide support against further downside.
The Trade and How to Express Your Opinion:
Buy VMW outright. At the time of this writing, Friday’s close was offered at $77.10. Dips post earnings were lower but never mind attempts to catch the lowest possible price. Any buy under $80 makes compelling sense to me. Value (the determination of which is subject to much perspective) is easily upwards of $90. VMW has traded with fits over $100, and represent opportune times to reallocate.
Or use options, considering volatility has moved higher with fear premiums on the rise make VMW an ideal case for Put writing. The following is a chart courtesy LiveVol. 360 day options implied volatility is continuing higher than historical volatility. Translation: Option sales are more advantageous than option purchases.
Importantly, I look to write the January 2016 Put (2017 is available with similar characteristics) at a strike that balances my personal risk tolerance with my thesis to profit. Many will argue shorter term contracts yield faster ‘theta’ (time decay), but doing so leaves us exposed to an ‘If Put’ price that is higher than I prefer. Also, shorter durations pay lesser premium and thereby lower our profit potential. Most all investors understand collecting premiums by writing options, but few implement the most effective strategy to maximize that sum against reinvestment risks at higher prices.
Specifically, the Jan 2016 $77.5 (ATM) Put can be sold for approximately $9.40. The spread isn’t too wide, but use limit orders (see the trade bar courtesy ThinkorSwim) and delivers a cost basis at $68.10 (strike less premium received). The low cost basis offers a margin of safety that is 9% below the current bid ($77.10). Furthermore, this trade sets up my If Put cost basis at a level VMW hasn’t touched since 2010.
Disclosure:
Short VMW Put options. The foregoing are not intended to be specific investment advice, but concepts to consider when investing. Consult your Investment Adviser.
