Investment Income Swells At Tight-Fisted EMC

A stabilizing force for any company, investment income, however, is not given as much weight by analysts and institutional investors as earnings from operations.

"Savvy investors are more focused on cash from operations," says Rob Joseph, an analyst at State Street Research.

Over the past three years, investment income at EMC has more than doubled, to $265.3 million from a hoard of cash and conservative investments that swelled to $5.1 billion at the end of last year from $4.7 billion.

EMC's ballooning war chest is being used sparingly even though its revenue is shrinking and rivals such as IBM are taking market share.

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"There's nothing wrong with a big bank account and virtually no debt," EMC spokesman Michael Gallant says.

But EMC's stock is off about 70 percent in the past year and management warned in January that its profit margins could remain depressed for several more quarters.

Gallant says EMC's conservative approach on investments allows the company to be flexible and quick, especially on the acquisition front. And analysts say the cash cushion is a good safety net while EMC attempts to transform itself into a storage software company.

EMC's last major acquisition was in 1999, when it used its skyrocketing stock to acquire Data General for about $1.1 billion. Data General's Clariion storage device helped EMC address the growing threat of much smaller Network Appliance Inc.

"I can't think of a company that they could buy now that would put them in a better market position," Walden Asset Management analyst Ellen Gorowitz says.

Meanwhile, analysts have noticed EMC's increased reliance on investment income to maintain its bottom line in the face of declining sales, margins and market share.

Investment income has been a longtime contributor to the company's bottom line, accounting for between 12 percent and 17 percent of its annual net income in the past five years.

But during the first half of 2001, before EMC ended the year with two consecutive money-losing quarters, investment income made up 27 percent of the company's net income. In the previous six-month period, that figure was only 12 percent.

Wall Street analysts are happy with the tight-fisted approach on investments. They point to EMC's generous spending on research and development, which totaled $928.7 million, or 13 percent of revenue, in 2001. In addition, EMC has acquired several small software companies in the past two years.

"A cash cushion is sensible and reasonable considering the risks at stake," Joseph says. "It's very hard to point to a hardware company that has transitioned to software. Any change in business model is very hard, particularly in technology."

To date, EMC's software sales have largely been tied to its flagship Symmetrix device. But EMC is moving to sell more software that runs on the machines of rivals--which analysts consider risky because it could devalue EMC's hardware franchise.

EMC's gross profit margins have plunged in the past year amid a price war with IBM and Hitachi Data Systems, a unit of Japan's Hitachi. Data-storage customers who have slashed their information technology budgets are no longer willing to pay the lofty premiums that EMC products once commanded.

There also is a perception that EMC's technology advantage, particularly for its refrigerator-sized machines that store vital information for banks, airlines and governments, is not as great as it once was, Gorowitz says.

"For EMC in particular, there's the worry that storage hardware is becoming more commoditized," she says.

EMC executives steadfastly deny the company's technology lead is narrowing. And they maintain that EMC is poised to move on the acquisition front should the right target present itself.

EMC tracks more than 200 start-up data-storage firms, looking for opportunities to add more functions to its software and hardware products.

"We are of a conservative mentality, but we move quickly if we need to," Gallant says.

EMC spent $120.7 million on software development in 2001 and spent another $112.5 million to buy two software development companies.

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