Because I am in a generous mood, I will use this post to provide heaping helpings of rumor and speculation, a pairing that can lead to nowhere or to valuable insights. Unfortunately, the tandem usually takes us to the former more than the latter, but let’s see whether we can beat the odds.
The topic today is the Virtual Computing Environment (VCE) Company, a joint venture formed by Cisco and EMC, with investments from VMware and Intel. VCE is intended to accelerate the adoption of converged infrastructure, reducing customer costs related to IT deployment and management while also expediting customers’ time to revenue.
VCE provides fully assembled and tested Vblocks, integrated platforms that include Cisco’s UCS servers and Nexus switches, EMC’s storage, and VMware’s virtualization. Integration services and management software are provided by VCE, which considers the orchestration layer as the piece de resistance.
As a company, VCE was formed at the beginning of this year. Before then, it existed as a “coalition” of vendors providing reference architectures in conjunction with a professional-services operation called Acadia. Wikibon’s Stuart Miniman provided a commendable summary of the evolution of VCE in January.
If you look at official pronouncements from EMC and — to a lesser extent — Cisco, you might think that all is well behind the corporate facade of VME. After all, sales are up, the business continues to ramp, the value proposition is cogent, and the dour macroeconomic picture would seem to argue for further adoption of solutions, such as VME, that have the potential to deliver reductions in capital and operating expenditures.
What, then, are we to make of rumored layoffs at VCE? Nobody from Cisco or EMC has confirmed the rumors, but the scuttlebutt has been coming steadily enough to suggest that there’s fire behind the smoke. If there’s substance to the rumors, what might have started the fire?
Second Thoughts for Cisco?
Well, now that I’ve given you the rumor, I’ll give you some speculation. It could be — and you’ll notice that I’ve already qualified my position — that Cisco is having second thoughts about VCE. EMC contributes more than Cisco does to VCE and its ownership stake is commensurately greater, as Miniman explains in a post today at Wikibon:
“According to company 10Q forms, Cisco (May ’11) owns approximately 35% outstanding equity of VCE with $100M invested and EMC (Aug ’11) owns approximately 58% outstanding equity of VCE with $173.5M invested. The companies are not disclosing revenue of the venture, except that it passed $100M in revenue in about 6 months and as of December 2010 had 65 “major customers” and was growing that number rapidly. In July 2011, EMC reported that VCE YTD revenue had surpassed all of 2010 revenue and CEO Joe Tucci stated that the companies “expect Vblock sales to hit the $1 billion run rate mark in a next several quarters.” EMC sees the VCE investment as strategic to increasing its importance (and revenue) in a changing IT landscape.”
Indeed, I agree that EMC views its VCE acquisition through a strategic prism. What I wonder about is Cisco’s long-term commitment to VCE.
Marriage of Convenience
There already have been rumblings that Cisco isn’t pleased with its cut of VCE profits. In this context, it’s important to remember how VCE is structured. The revenue it generates flows directly to its parent companies; it doesn’t keep any of it. Thus, VCE is built purely as a convenient integration and delivery vehicle, not as a standalone business that will pursue its own exit strategy.
Relationships of convenience, such as the one that spawned VCE, often do not prove particularly durable. As long as the interests of the constituent partners remain aligned, VCE will remain unchanged. If interests diverge, though, as they might be doing now, all bets are off. When the convenient becomes inconvenient for one or more of the partners, it’s over.
It’s salient to me that Cisco is playing second fiddle to EMC in VCE. In its glory days, Cisco didn’t play second fiddle to anybody.
In the not-too-distant past, Cisco CEO John Chambers had the run of the corporate house. Nobody questioned his strategic acuity, and he and his team were allowed to do as they pleased. Since then, the composition of his team has changed — many of Cisco’s top executives of just a few short years ago are no longer with the company — and several notable investors and analysts, and perhaps one or two board members, have begun to wonder whether Chambers can author the prescription that will cure Cisco’s ills. Doubts creep into the minds of investors after a decade of stock stagnancy, reduced growth horizons, a failed foray into consumer markets, and slow but steady market-share erosion.
Alternatives to Playing Second Fiddle
Meanwhile, Cisco has another storage partner, NetApp. The two companies also have combined to deliver converged infrastructure. Cisco says the relationships involving VCE’s Vblocks and NetApp’s FlexPods don’t see much channel conflict and that they both work to increase Cisco’s UCS footprint.
That’s likely true. It’s also likely that Cisco will never control VCE. EMC holds the upper hand now, and that probably won’t change.
Once upon a time, Cisco might have been able to change that dynamic. Back then, it could have acquired EMC. Now, though? I wouldn’t bet on it . EMC’s market capitalization is up to nearly $48 billion and Cisco’s stands at less than $88 billion. Even if Cisco repatriated all of its offshore cash hoard, that money still wouldn’t be enough to buy EMC. In fact, when one considers the premium that would have to be paid in such a deal, Cisco would fall well short of the mark. It would have to do a cash-and-stock deal, and that would go over like the Hindenburg with EMC shareholders.
So, if Cisco is to get more profit from sales of converged infrastructure, it has to explore other options. NetApp is definitely one, and some logic behind a potential acquisition was explored earlier this year in a piece by Derrick Harris at GigaOm. In that post, Harris also posited that Cisco consider an acquisition of Citrix, primarily for its virtualization technologies. If Cisco acquired NetApp and Citrix, it would be able to offer a complete set of converged infrastructure, without the assistance of EMC or its majority-owned VMware. It’s just the sort of bold move that might put Chambers back in the good graces of investors and analysts.
Could it be done? The math seems plausible. Before it announced its latest quarterly results, Cisco had $43.4 billion in cash, 89 percent of which was overseas. Supposing that Cisco could repatriate its foreign cash hoard without taking too much of a tax hit — Cisco and others are campaigning hard for a repatriation tax holiday — Cisco would be in position to make all-cash acquisitions for Citrix (with a $11.5 billion market capitalization) and NetApp (with a $16.4 market capitalization). Even with premiums factored into the equation, the deals could be done overwhelmingly, if not exclusively, with cash.
I know the above scenario is not without risk to Cisco. But I also know that the status quo isn’t going to get Cisco to where it needs to be in converged infrastructure. Something has to give. The VCE open marriage of convenience could be destined to founder on the rocks of irreconcilable differences.