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VMware sales slowdown triggers stock meltdown

Fun while it lasted

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The VMware orgasm officially ended Monday, as the virtualization software maker revealed that it could no longer match "the market's" lofty expectations.

VMware officials, during an conference call to cover their fourth quarter earnings, forecast revenue growth of just 50 per cent in 2008. We say "just" because the company has enjoyed close to 100 per cent year-over-year growth over the past nine years. Making matters worse, VMware revealed that a large chunk of its growth will consist of services and deferred revenue. This left at least one analyst on the conference call, saying VMware's figures had him expecting 2008 product revenue growth of between just 30 and 40 per cent.

Since it IPOed last August, VMware has largely enjoyed the blessings of analysts and investors. They've sent VMware's shares skyrocketing based on the belief - however irrational - that it would continue to increase revenue at amazing rates even as the size of the company grew, making historical comparisons near impossible to match.

Well, the investors returned themselves and VMware to reality today. Shares of VMware tumbled more than 25 per cent in after-hours trading to $61, at the time of this report.

For the fourth quarter, VMware reported an 80 per cent rise in revenue to $412m. Net income more than doubled to $78m from $31m reported in the same period last year.

For the full year, VMware's revenue hit $1.33bn - up 86 per cent from 2006. The company's full-year net income came in at $218m, which compares with $86m in 2006.

Digging into the 2007 revenue, VMware revealed that 38 per cent of its product revenue came from so-called "platform" products such as its base hypervisor and VMware Workstation. Meanwhile, management products accounted for the other 62 per cent. Last year, platform sales dominated the full year figures, accounting for 57 per cent of sales, while management products accounted for 43 per cent.

VMware likes to point out this shift toward management revenue because it holds a substantial lead over rivals with this type of more sophisticated software. The likes of Microsoft and Citrix have only just started adding management bits around their base virtualization software.

Analysts couldn't care less about any of that at this point. VMware has demolished their triple-digit hopes and dreams.

After hearing the forecast for 50 per cent revenue growth in 2008, one analyst on the conference call said, "It just doesn't seem to add up. It just doesn't seem to add up. It just doesn't jive with peoples' expectations."

To the analyst's point, VMware management dropped a serious bomb on Wall Street. Executives have spent months deriding competitors' products, while championing the growth of the virtualization market out the other side of their mouths.

Today, however, they exhibited more caution with CEO Diane Greene saying, "We have to see how fast the market grows overall."

Greene's message was that VMware remains bullish about its products and position relative to competition, but is a tad more cautious about how much demand customers will show for virtualization software.

No sane person expected VMware to keep on doubling software revenue forever, although the company's valuation indicates that many investors thought it would double revenue for quite a bit longer. Ultimately, moving a company from $1.3bn in revenue to $2.6bn in one year would be a very rare feat, especially with SWsoft, Microsoft, Citrix and a host of others looking for a piece of your action.

Still, we're pretty sure that some of the analyst shock comes as a result of VMware's unparalleled optimism. Even with all this competitive pressure mounting, VMware said it has no intention of lowering the price of products. It will simply keep adding new features. And, as mentioned, executives continue to maintain that VMware faces no real competitive challenge.

So, for VMware to wallop Wall Street with word of a major growth slowdown was "very extreme," as one analyst put it.

Meanwhile, VMware's CFO Mark Peek assured analysts that they were just watching growth in motion.

"(This) is largely a function of us becoming a very large software company," he said. ®

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