By Alex Gavrish, Etalon Investment Research; author of “Wall Street: Back to Basics

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David Einhorn initiates a position

In its recent quarterly letter to investors, David Einhorn of Greenlight Capital disclosed that his fund made a new medium-sized long investment into shares of EMC Corporation (NYSE:EMC). In terms of logic behind the investment, Einhorn did not tell investors anything new and only reiterated the well-known and old thesis that EMC trades at the discount to sum-of-parts valuation because it operates few businesses under one roof. There is nothing here that we did not know before. We highlighted EMC in our January 8th, 2014 article, in which we emphasized EMC Corporation’s attractive valuation, strong free cash flow generation and large share buyback program. Its stake in VMware, Inc. (NYSE:VMW) provides a built-in “margin of safety” because as a result of this holding, EMC shares are discounted by the market. Since our recommendation, shares of EMC advanced 15%. We believe that EMC shares still represent a very attractive long-term investment opportunity. As Einhorn joins another activist investor, Elliott Management (who urged EMC to spin-off VMware) we decided to write a short update on the valuation.

In Elliott’s Q3 letter, Paul Singer stated:

[drizzle]During the quarter, Elliott disclosed a 2.2% stake in EMC Corporation, a $55 billion  market capitalization company that is the leader in storage systems. EMC has developed  a high-quality set of assets, including an 80% stake in VMware, Inc., a $40 billion market  cap company that is the leader in virtualization software for data centers. Though EMC is  a leader in numerous markets with very good products, EMC’s stock price has deeply  underperformed its proxy peers. The driver of this underperformance is EMC’s unusual  corporate structure, which management calls “The Federation.” This structure, which may have served EMC well years ago, no longer has demonstrable benefits. The upside  to EMC shareholders of a tax-free spin-off of VMware would be enormous, potentially  exceeding 40%. Our constructive dialogue with EMC has enabled us to communicate to  the company our views on the VMware spin-off and other pathways to shareholder value  creation, and we look forward to continuing this dialogue in the months ahead.

Current valuation

Based on a recent price of $29.31 per share, EMC Corporation (NYSE:EMC) has a market capitalization of $60 billion and an enterprise value of $57 billion. EMC also has approximately $7.2 billion in long-term investments on its balance sheet, which consist of debt securities with maturities longer than 1 year, part of them being held by VMware, Inc. (NYSE:VMW), EMC’s subsidiary. After taking into account long-term investments, company’s adjusted enterprise value stands at $50 billion. Using this adjusted enterprise value figure, the company is valued at an EV/EBITDA multiple of x8.6, based on 2013 financial results and at an EV/EBITDA ratio of x9.7 based on annualized 9 months of 2014 financials. In the first nine months of 2014, EMC generated a free cash flow of $3.2 billion and $5.5 billion of free cash flow in 2013. EMC owns a 80% stake in VMWare, which, based on a recent price of VMWare’s shares, is valued at $29 billion and represents 48% of EMC’s current market capitalization.

Share buybacks and dividend

EMC Corporation (NYSE:EMC) has a large share buyback authorization in place. During 9 months of 2014, company spent $1.4 billion on share repurchases, and an additional $450 million was spent by VMware, Inc. (NYSE:VMW) to repurchase its own stock. EMC currently pays regular quarterly dividend of $0.115 cents per share, which provides an annual dividend yield of 1.6%. According to share repurchase plans specified in company’s latest quarterly report, EMC intends to spend $3 billion on share repurchases during 2014. This implies that during fourth quarter of 2014 EMC can spend $1.2 billion buying back shares. We believe that regardless of what will happen to company’s stake in VMware and whether activist investor’s proposals to spin-off VMware will be adopted, shares of EMC provide an attractive holding for long-term, value-oriented investor.

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