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EMC sinks on warning, storage sector in tow

The storage bellwether's profit warning is so huge, it prompts analysts to question its business model and issue another round of estimate cuts for the company's enterprise companions.

EMC's profit warning was so huge it prompted analysts to question the storage bellwether's business model and issue another round of estimate cuts for the company's enterprise companions.

Analysts downgraded shares of the leading enterprise storage company Friday and said estimates for future results were merely "stabs in the dark," as management refused to comment on anything beyond the second quarter. One thing analysts could be sure of is that the magnitude of EMC's miss means profit warnings from other leading technology companies can't be far behind.

Shares were off $8.43, or 28 percent, to $21.60 Friday. The warning also reverberated throughout the storage sector; CNET's Storage index was down 26.76 percent.

EMC warned Thursday evening that earnings per share will be 4 cents to 6 cents for the second quarter, well below First Call's consensus estimate of 17 cents a share. Revenue is now expected to be about $2 billion; most analysts were expecting around $2.4 billion, even after lowering estimates.

Analysts expressed surprise at the magnitude of the miss, though most had expected the company to make a pre-announcement.

"The revenue shortfall did not startle us, but the (earnings) results surprised us," said Merrill Lynch analyst Tom Kraemer, who downgraded the stock to "neutral" from "buy." He had already lowered his earnings estimate to 17 cents back in April, well before the Street's consensus came down to that number. The sharp miss from that number suggests "that hardware pricing, volume shipments and software sales fell precipitously below expectations," Kraemer wrote.

Analysts had expected falling hardware prices to hamper EMC's performance, but had thought the company would offset the shortfall with higher-margin software, Kraemer said. Its inability to do so was his biggest concern about the company.

Other analysts likewise questioned the company's business model and its position in the shifting competitive landscape.

"EMC's substantial second-quarter pre-announcement raises questions about its model," said Goldman Sachs' Laura Conigliaro. The analyst cited issues centering around "pricing, competitive impact, sustainable gross margins and growth rates."

"The miss and sharply lower gross margins (are) symptomatic of not just (a) soft IT spend(ing) environment, but increasing competition," wrote SG Cowen analyst Richard Chu, who downgraded the stock to "neutral" from "buy" Friday. Though EMC "remains the clear leader in the enterprise storage market," it's facing increasing competition from IBM and Hitachi Data Systems, Chu wrote.

Future in dark, mixed view on stock
The other big issue analysts had with the company's pre-announcement was the complete absence of projections beyond the second quarter. EMC left analysts in the dark, saying it would give more projections on its July 18 conference call, when it reports official second-quarter results.

"With no guidance whatsoever at this point," Chu said, his revised estimates are a "stab in the dark."

Chu predicts revenue will be flat sequentially for the third quarter at $2 billion, with a fourth-quarter rebound to $2.36 billion, which will still leave it down 10 percent year-over-year.

That will make revenue for the year $8.7 billion, or down 2 percent over last year's. The number is a far cry from the $12 billion EMC had forecast back in January.

"Estimates changes, though imprecise, will be deep," wrote Conigliaro, who also predicted 2001 revenues would come in around $8.7 billion, down from her previous estimate of $9.6 billion. The stock's valuation was the one thing analysts had difficulty agreeing upon.

There were more bullish analysts, like Deutsche Banc Alex Brown's George Elling, who is maintaining his "strong buy" rating and lowering his stock price target to $40. But other analysts questioned the stock's worth at even half that value.

"Even at the expected opening price of $25, valuation seems high," said Thomas Weisel Partners analyst Doug Van Dorsten, who lowered the stock's rating to "market perform" from "buy."

And analysts' usual refrain?"buy on weakness"--was notably absent from their research reports Friday. "We think investor uncertainty regarding the impact of competition...makes it premature to be aggressive on EMC shares on weakness," Chu wrote.

EMC's warning also prompted analysts to question their estimates for competitors.

Goldman's Conigliaro made "another round of estimate reductions" for Brocade Communications Systems, down $8.88 to $31.89; IBM, down $5.60 to $106.50; Network Appliance, off 89 cents to $11.78; and Sun Microsystems, down $1.49to $13.68, as a result of EMC's "disturbingly wide miss."

Bear Stearns analyst Andrew Neff said the magnitude of EMC's miss also raised concerns about potential warnings for that same group, but added Compaq and Hewlett-Packard to the list.

"Although we see little that makes us want to invest heavily in these names immediately, at some point confidence levels and forecasts will begin to firm up," Conigliaro added on a positive note.