 From the SiliconANGLE Media office in Boston, Massachusetts, it's theCUBE. Now, here's your host, Dave Vellante. Hi everybody, welcome to this breaking analysis. This is Dave Vellante, and VMware announced yesterday its quarterly results, and it also announced the acquisition of two companies, Pivotal, which was the news was broken before the earnings announcement, but also Carbon Black, a Walton, Massachusetts based security company. And you may be wondering, what the hell is VMware up to? What are they doing? And I want to sort of unpack that and explain it to you from my perspective. So Pivotal and Carbon Black are getting paid 2.7 billion and 2.1 billion dollar respectively is the value of those deals. So VMware is paying an enterprise value to sales ratio of 3.8 and 7x respectively for Pivotal and Carbon Black. The motivation here in my view is really to clean up Pivotal. I'm going to explain that in a second. And also to increase VMware's cloud, multi-cloud and recurring revenue contributions. Today the SaaS business of VMware is only about 12% of the company's revenue. So they want to increase that because they want to have a cloud-like model and recurring revenue. The challenge for a company like VMware who's largely based on perpetual license models upfront get paid for the whole license and then you do some maintenance is it's like a heroin injection. You get the big rush of cash whereas with the recurring revenue model you're streaming it out over and deferring it over 12 or 36 month or 24 month period. And so the revenue impact is somewhat negative on the income statement. And that's putting a little bit pressure on the stock but VMware management understands that that long-term it's a much more predictable and attractive business model to be a SaaS company than it is to be a traditional license-based perpetual license-based software company. Now the pivotal deal is somewhat complicated. And of course when Michael Dell's involved we tend to have these complicated transactions. His organization is very savvy in terms of from a financial standpoint, we saw that. Remember when Michael Dell and Silver Lake bought EMC for $67 billion, they shelled out only only $4 billion of their own cash. Now they took out a lot of debt but it was a very interesting and complicated financial transaction. So part of this is cleaning up some of that transaction that I'll explain. In my opinion VMware is getting a pretty good deal for both Pivotal and a decent deal for Carbon Black. So let me explain. First of all Alex if you would bring up the chart on Pivotal, let's take a look at it. Now you can see here Pivotal did its IPO last year. It went IPO was I think close to a $4 billion valuation and you can see the stock has not performed well. Subsequent to that it was never able to get back to its IPO price. It had a decent uptick in March of this year as the market was running up and you can see the earnings miss in the late spring, early summer back in the June announcement date. Big hit there. The company's been struggling in the marketplace. It's got a lot of assets. Remember Pivotal was originally put together as a collection of what I used to call misfit toys. Some of the EMC assets, some of the VMware assets they put together, Polymer, it's created this entity to try to create a platform for application development. Michael Dell saw this as an opportunity to take it public and actually create another asset in part of the Dell family. But you can see here post June the decline in the stock price and then you see the announcement from VMware, the rumor that came out. Actually it was an announcement that came out in the press this week and the stock jumped over 70% on a day when the Dow dropped 800 points. But you can see now the today's price it was 14.88 when I took this snapshot. About 50 cents on the dollar from the IPO price. And so you can see that VMware and Michael Dell are kind of doing the top cat. They did the IPO that pulled the coin back and now they're going to repurchase the stock. So kind of interesting, but here's what the interesting part is that VMware is only paying $900 million in cash to the public shareholders. How can that be? So here's the deal. VMware already owns about 15% of Pivotal where Dell owns about 70% of the company. So what's happened by the way, Michael Dell controls 95% of the voting shares which is why one of the reasons why this stock really never took off it's one of those ownership structures and governance structures where a single individual really controls the stock. So that oftentimes keeps stock prices down. But nonetheless, Dell's 70% is being exchanged for VMware stock, for Pivotal stocks that are owned by Dell. So let me read you the statement, Alex. If you could bring up that statement from the earnings call, this is from the VMware CFO explaining the mechanics. With regards to Pivotal, VMware has agreed to acquire Pivotal at a blended price per share of $11.71, comprised of $15 per share in cash to public stockholders. That's why the stock is trading at $14.88 today and a little bit of arbitrage flowed in there. And VMware's Class B common shares exchange for Pivotal Class B common shares held by Dell Technologies and an exchange rate of 0.055 VMware shares for each Pivotal share. The transaction has an, excuse me, enterprise value of $2.7 billion. Dell Technologies will receive approximately 7.2 million shares of VMware Class B common stock. And aggregate this results in an expected net cash payout for VMware of 0.8 billion, I said 0.9 billion. The impact of the equity issue to Dell Technologies would increase its ownership stake in VMware by approximately 0.34 percentage points to a total of 81.09% based on the shares currently outstanding. As I said, VMware currently holds 15% of outstanding shares of Pivotal. Once closed, we'll update blah, blah, blah. So Michael Dell's buying VMware stock. He's increasing his share of VMware, which is also a kind of an interesting side note. But now let's look at the Pivotal fundamentals. Does this make strategic sense? Yes, in my opinion, why is that? This is all about containers and it's all about next generation application development for cloud. It's also a hedge for VMware. Everybody said containers are going to kill VMware. Well, it's a hedge in the instance that containers start to impact VMware's traditional virtualization business. Now, as I showed yesterday on the video where I was looking at ETR research, there's no evidence today that containers are slowing down the spending on VMware. You deploy containers in many, many ways. Certainly they're deployed in bare metal and that's somewhat of a risk to VMware. But they're also deployed on top of virtual machines, on top of VMware. Right now, it's not been a negative for VMware and by acquiring Pivotal, it can bring those synergies into the VMware mothership which is Dell's software mothership, I call it. And there's also synergies in sales and marketing and R&D and it kind of cleans up Pivotal and consolidates the assets. Now, let's look at Carbon Black. This is a security play and it's really a different story than Pivotal. First, you've got to remember that Pat Gelsinger told John Furrier and me several years ago in theCUBE that security is a do-over. And I'll tell you right now, Pat Gelsinger and VMware are architecting a security do-over. You've got on-prem, you've got hybrid, you've got cloud, you've got multi-cloud. Traditional security models aren't going to cut it. So let's look at this clip by Pat Gelsinger and it'll give you a sense of how he and VMware are thinking about the future. Watch this and we'll come back and talk about it. Steve Herrod on our crowd chat pregame on Friday with the hot opportunities are for startups. He said security are mainly not getting caught at this perimeter-based security. What's your view on that? Well, the crusty, the hard crusty exterior and the soft gooey inside, as I described it this morning, my morning breakfast every day. And with it, this whole idea of micro-segmentation and NSX really redefines how you build networks. And that's going to allow us to refactor every aspect of security, every aspect of routing and load balancing, et cetera. Okay, so what Pat was saying is he's talking about micro-segmentation, NSX, the critical acquisition from NICERA. Refactoring security and everything. Security is a do-over. Okay, Alex, let's bring up the chart of carbon black. I want to look at that and explain to our audience kind of what's going on there. So you can see it's a little bit of a different picture from Pivotal. You've got that kind of bathtub look to it. So you see at the IPO, it was a hot company, but it underperformed and it was struggling there. Coming into the end of last year and then into 2019, you could see it was kind of bouncing around at its lows. And then what happened was you saw earlier this year, the company guided down. So you can see that big drop in the February announcement, big spike downwards. They guided down the CFO resign and there were several downgrades from Wall Street analysts and that really crushed the stock. But then you're sort of bouncing back through May and then what happened is, you had this growth company, they've grown at 25 to 30% a year and they beat earnings estimates in May. So they guided down in February but then they beat and you had a new CFO, you just kind of had this new renewed emphasis on the company. And then this summer they hired Morgan Stanley. And so the acquisition rumors started and you can see into August it starts to pick up again. So I have no doubt that this was a competitive bid of VMware wanted it. So here's another comment that I want to share with you from last year at VMworld. And again, it'll give you an additional insight as to how Pat Gelsinger is thinking about the future. Go ahead and play the clip and then we'll come back. Kind of things are brought together into my application. And in that sense, the application is a network of these different services, data sources, et cetera. And we believe in that, you know, bridging across silos isn't important. It is essential to do that. You know, because as you say, security models across that, you know, how does the, you know, when that application isn't performing like I expected to, how do I go even debug it? So think about what Pat said. The application is a network of services. It's not essential, it's not important. It's essential that we deliver that in a consolidated model, including security models. Okay, so you got VMware looking to make its platform the place to run modern apps. You got Carbon Black, a $250 million company, trading at a discount of about 5.5 X revenue. They got strong growth at the time, a 25 to 30% a year that's consistent. And then nearly 40% of its business is coming from the cloud. And the cloud business is growing at 70% a year. So VMware, remember, Jettisoned it, it's cloud business, vCloud Air, but it still has a desire, it covets participating in cloud, at least in the form of multi-cloud and on-prem cloud-like experiences. Carbon Black is a modern endpoint security company. You heard John's question about the perimeter and you know you can't build moats anymore. You really, endpoints are really the new vulnerability, especially when you start thinking about IoT. So VMware is desirous of cloud revenue, multi-cloud and recurring revenue. You got a growth company that's looking to sell. They've got leading technology, as they said. This was a competitive bid and VMware wanted it. So now the other thing is VMware knows Carbon Black. They've integrated Carbon Black into its app defense offering and VMware has been expanding its portfolio not so quietly lately. App defense, NSX has a, with its micro segmentation is really a security use case. AirWatch has a security component. Cloud Corio, E8 security was another acquisition. Bracket Intrinsic was, you know, these little tuck-ins sort of draw a picture of how Gelsinger and VMware are starting to build out its portfolio, again, making VMware the software and mothership security is a critical component of that. It also gives VMware much more of a strategic entrance into the C-suite, particularly with the Chief Information Security Officer. We've talked many times on theCUBE that security is now a board-level discussion to the extent that VMware can be the platform for multi-cloud security. And of course, that's not assured, right? They're battling Cisco who's coming at it from a network position. They're battling Google who's announced Anthos. They're certainly battling Microsoft. Certainly IBM and Red Hat have similar designs. And as we've said, watch this space. Amazon ultimately we think is going to get into this area. But anyway, VMware is making security a fundamental part of its platform. It's bridging those silos is what Pat Gelsinger talked about in the video, and giving you access to sets of infrastructure. So with Pivotal, it's building out, you know, in cloud-native application development and tooling, container technology, and that's clearly strategic to its multi-cloud strategy, helps VMware stay relevant. VMware doesn't own a cloud, so it's got to move fast and be first in this multi-cloud space. Okay, so let me summarize. VMware is going to spend 2.7 billion on two key acquisitions. They're going to add, it's going to add a billion dollars and two points of revenue growth that's largely in SaaS and hybrid cloud and recurring revenue for VMware and three billion dollars in year two. Now let me do some Volante math for you. VMware trades at about five to six times revenue. So essentially they just added five to six billion dollars in market value in year one. And by the way, the stock is off 8% today. So because of these acquisitions. So and it's got upside in my view, assuming that there's not some big economic downturn. But we're talking about 15 to 18 billion in market cap in year two. So this accelerates VMware's transition to SaaS. It's a cash flow positive and a creative acquisitions in year two, according to VMware. VMware throws off nearly $4 billion in annual and operating annually and operating cash flow. To me, this is a good use of cash. Balancing acquisitions and to continue growth and tuck in your ability to be that platform for cloud and multi-cloud services and hybrid cloud is a good use of cash. I like it better than stock buybacks, frankly. So a combination of stock buybacks, organic R&D, which VMware's very strong engineering culture and acquisitions. In this case, using your stock as currency, I like the deals. We're going to watch them very closely and we're going to be talking about this next week at VMworld. So watch theCUBE at VMworld, theCUBE.net. We'll be there myself, John Furrier, Stu Miniman, Jeff Frick, the entire team celebrating our 10th year at VMworld. If you have any questions on this or comments, please tweet me at D-Valante. Thanks for watching everybody. We'll see you next week.