Original URL: http://www.theregister.co.uk/2011/08/23/vce_a_startup/

Storage world punch-up over whether VCE is a start-up

EMC: $40m-a-quarter losses are 'expenses'

By Chris Mellor

Posted in Storage, 23rd August 2011 08:32 GMT

Comment Is VCE, the VMware-Cisco-EMC entity set up to sell integrated virtualised server-networking-storage Vblocks, a startup? And how is it doing, given EMC's revelation that VCE is costing it more than $40m a quarter?

VCE was originally set up as Acadia in November 2009, to integrate and sell Vblocks and provide an initial period of operational support for customers. It began life with a 130-employee headcount and funds from the three founding companies, plus Intel.

It changed its name to VCE – the Virtual Computing Environment company – in January this year, and supplies Vblocks as single products with a single SKU (stock keeping unit) through a network of partners, 130 or so of them, who get pre-built Vblocks. VCE says it was formed by Ciso and EMC with investments from VMware and Intel. We understand EMC owns 58 per cent of VCE and Cisco 35 per cent, leaving 7 per cent for VMware and Intel.

In January VCE had more than 100 customers with average Vblock deal size of $2.5m and a 40 per cent month by month growth rate, plus a $1.2bn pipeline. At that point El Reg estimated VCE accumulated sales revenue was $262.5m.

The EMC SEC filing in August revealed EMC's accumulated VCE losses were $132m out of total contributed funding of $181.3m; that's $173.5m cash and $7.8m in stock options. EMC's VCE investment lost $41.9m lost in the March quarter and $46.6m in the June quarter. We observed that, if viewed as a startup, VCE did not appear that successful. This resulted in quite strong disagreement, as seen here for example.

Is VCE a startup?

Is VCE a startup? Not in the classic Silicon Valley sense, no.

A typical startup involves founders inventing a new product, building a prototype with their own or angel investor funding, getting a demonstrable technology with the prototype, gaining VC funding and building a product...

Their company is started up from scratch and staffed by people new to it. It develops the product, brings it to market, and then markets and sells it, with possible further rounds of funding to build sales and marketing and support operations as well as develop the product further. Eventually and hopefully the new company has a strong enough pipeline of business for profitability to be reliably coming or present and goes public, or is bought, with its VC backers cashing out.

Wikibon's David Vellante stated: "EMC and Cisco spotted a trend and acted like VCs for a change — by creating a startup that could get to market fast."

Mark Hopkins of Silicon Angle says VCE is a startup: "When we talked to Michael Capellas at EMC World in 2010, he characterised the work he was doing with Acadia, the predecessor to VCE, as very start-up-ish in nature. Later in 2011, when I was at SxSW in Austin this year, I met Jay Cuthrell [managing principal vArchitect at VCE] in the bloggers' lounge, who without provocation extolled the virtues of the VCE startup culture."

Hopkins had some strong words for El Reg. He said: "This is a world that the Register isn’t plugged into, nor are they usually responsible to their audience for understanding this. That combined with their tendency towards sensationalism, and it's not surprising it wouldn't even enter into their minds that this company indeed truly functions like a startup, nor would the thought to compare VCE's progress at 18 months to other startups at 18 months... So, even when you evaluate VCE (purely as a startup) and compare them to their enterprise startup peers [like 3PAR], there's absolutely no shame in not being profitable at 18 months."

But VCE is not a startup in the Silicon Valley sense at all, I'd argue, being, in essence, a joint venture to integrate existing and successful products all with a great track record of success.

It was staffed by people who know the products and sold largely through a channel that knew the individual products too. In other words it did not have to develop substantial technology or IP at all, being merely a system integration exercise joint venture by, largely, Cisco and EMC.

Its startup expenses, compared to a Silicon Valley startup developing new hardware, should have been a lot, lot less. It could hit the ground running, selling bundles of known and successful products to customers who knew and trusted the products and their suppliers.

That's hardly like 3PAR, a then unknown company, selling a brand new product and technology to customers who had to be convinced to take a big risk in buying it.

VCE numbers

VCE did not really have to develop any significant IP at all in fact, so its start costs were basically staffing and facilities.

VCE is now in the 18 months-plus after product launch phase, and we see that it is still costing EMC money, to the tune of $40m plus a quarter. Yet it has made revenues, we estimate, of $262.5m. Extracting EMC's proportion of that, 58 per cent pro rata, gives us $152.25m.

So EMC has put in $181.3m, made $152.25m, leaving $29.05m, yet has accumulated losses of $132m and is doing so at a rate of $40m-plus per quarter. At this rate it will have to put in more funding, unless VCE sales rise significantly.

What has happened to the $152.25m of VCE revenues that EMC appears to be entitled to? How can it have lost $132m yet seen $152.25m come in? VCE must have been spending a lot of cash...

One source suggests total VCE losses are: "about $228m as of June 2011."

This VAR guy goes on to say: "Barring a change of direction it sounds like the losses will continue. Back in [a] May 2011 SEC filing, Cisco indicated over the next 12 months, as VCE scales its operations, '[Cisco] expects that it will make additional investments in VCE and may incur additional losses, proportionate with the company's ownership percentage'."

The same would be true of EMC.

Wikibon's David Vellante says: "I think VCE has spent heavily. It has had to restructure strategy and messaging to protect its partners. It has been spending money like crazy and has had to get more disciplined. It will continue to alter the operating model. But to conclude that VCE is failing is in my view way off base and at the very least grossly premature."

As a comparison point, NetApp has its Flexpods, Vblock-like bundles that are, practically speaking, Vblocks with NetApp storage sold by NetApp's channel. With no VE structure to support, we'd assume Flexpod sales return profits to NetApp whereas, as EMC's SEC filing reveals, Vblocks don't yet return a profit to EMC.

EMC's view

An EMC view is that, SEC filings apart, VCE losses are not losses but expenses. Here's EMC's Chuck Hollis commenting on the VAR guy's blog: "I understand what you're trying to say here, but I think you've missed a fundamental point — the revenues associated with VCE flow back to the parent companies, and aren't broken out separately. Put differently, the 'losses' you're writing about are actually 'expenses'. They're offset by revenue that show up elsewhere. And none of the parent companies break out revenue to that level of detail."

There has been a sequence of comments about VCE and Vblock sales by EMC's CFO, David Goulden, and by Joe Tucci in recent EMC earnings reports. Here they are:

David Goulden in April this year:

With our expanding pipeline, VCE opened its headquarters in Dallas last month and will soon open offices in San Jose, Raleigh/Durham and London.

Given the market momentum, we are accelerating our investment in VCE ... We're increasing our projection for other expense in 2011 by approximately $70m. The accelerated VCE investment is reflected here, as are changes in the operating effects associated with VCE. However, we expect improvements to our operating margin from Vblock-related sales to effectively offset most of this increase in other expense during 2011.

David Goulden in July:

Momentum continues to build at VCE. We have seen substantial demand from small and large customers, as well as partners, who appreciate Vblock's converged, best-of-breed, virtualised infrastructure and VCE's revenue for the first half of 2011 already exceeds the revenue it achieved all of 2010.

As VCE grows, we are seeing increasing sales to repeat customers who are standardising their next-gen data centers on the Vblock and moving their enterprise workflows into full production on Vblock platforms.

Joe Tucci in July:

Our joint venture with Cisco, VCE, continues to grow in both revenue and relevance. Customer interest in the Vblock converged technology is extremely high and the installed base of Vblocks is performing very well. For sure, Vblocks are proving their value proposition and we expect Vblock sales to hit the billion-dollar run rate mark in the next several quarters."

We are left with the knowledge that EMC is asserting Vblock sales are rising steadily and there is strong customer interest. VCE is costing EMC money right now but EMC hopes and expects Vblock sales to reach billion dollar annual run rates in the "next several quarters" when it would then, obviously, be profitable.

Four quarters would take us to this time next year and we might expect profitability to be reached by then, and, possibly, unit ship numbers to be revealed or indicated.

If VCE were a Silicon Valley start-up its backers would probably never have countenanced such an ambitious infrastructure build-out and, assuming they had, would be scaling it back to stop it running out of cash.

Ironically there are rumours of VCE layoffs but these are, emphatically, rumours. Commenting on this point and saying he didn't know about that, Hollis said: "Just about every IT vendor in the industry is continually refining their labour model these days — adding and subtracting to get the right mix. To do otherwise would be foolhardy." ®