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EMC-Dell talks reflect a data storage industry in flux

Why would the data storage giant EMC Corp.put itself on the auction block? And why would computing powerhouse Dell Inc. want to buy the Hopkinton company?

Industry analysts say such a deal is probably being driven by major changes in the ways that individuals and businesses manage their digital lives.

Dell and EMC are in talks about a combination that would give Dell control of the world’s leading maker of storage hardware and software for large organizations, The Wall Street Journal reported Wednesday evening. A transaction probably would value EMC at about $50 billion, making it the largest ever in the tech business, though there is no guarantee a deal will be sealed, the Journal said.

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EMC is highly respected and solidly profitable. But demand for the “big iron” data-storage systems that made the company’s fortune has fallen. One major reason is the growing number of businesses that rely on cloud-storage services run by Dropbox Inc., Amazon.com, Microsoft Corp., Google, and others. Cloud services run large data centers with vast data-storage arrays, letting users store their data online, rather than on a local computer. Cloud services are popular because they’re cheap and because users can access their data anytime and anywhere.

Of course, the cloud companies need storage too, but “they’re building their own,” said Glenn O’Donnell, research director at Forrester Research in Cambridge, “because it’s cheaper and more cost-effective to do that.”

Cloud companies buy millions of blank, generic hard drives, assemble them into storage arrays, and manage them with their own custom-made software.

No EMC required.

Steve Duplessie, senior analyst at Enterprise Strategy Group in Milford, estimates that about half of all newly created data files are stored on public cloud services like Dropbox, rather than on companies’ own internal storage systems. For example, many employees keep their files on Dropbox or Google Drive so they can get to them at home or on the road. Duplessie called it “data leakage,” and it’s draining away demand for corporate purchases of EMC hardware.

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As a result, Duplessie said, “the storage business we’ve known and loved for 40 years is completely stagnant.”

Sales of traditional EMC products grew just 2 percent in 2014.

Luckily, EMC has made smart bets on a number of high-growth sectors. Most famously, in 2003 it acquired VMware Inc., a maker of virtualization software, for $635 million. VMware today has a market capitalization of $34 billion, and its revenue grew 16 percent last year.

VMware makes products that allow a business to treat thousands of separate servers as one giant pool of data-processing power or data storage. This lets companies use their existing hardware far more efficiently, reducing the need for them to buy more. Indeed, VMware’s success is one reason businesses aren’t buying as many computers and storage servers as they used to.

The hedge fund Elliott Management Corp., which owns 2 percent of EMC, has long urged chief executive Joseph Tucci to sell the company’s 80 percent stake in VMware and pay the money to shareholders. (A piece of VMware is publicly traded.)

Instead, VMware could become a major growth driver for Dell. In addition, Ashish Nadkarni, a storage analyst at IDC Corp. in Framingham, noted that Dell sells VMware software with many of its enterprise servers. “If Dell owned VMware,” said Nadkarni, “they would own that revenue.”

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EMC has also gained a solid foothold in one of the fastest-growing storage segments: flash arrays that use chips instead of spinning hard drives. Flash arrays are more expensive than hard drives, but they’re more reliable and handle data far faster, so businesses are switching to flash for their most speed-critical storage applications.

EMC was the market leader in flash arrays in 2014, with 31 percent of the market worldwide, according to Gartner Inc.

The flash business is tiny compared with EMC’s spinning-disk business. All vendors combined posted worldwide revenues of $1.4 billion last year, according to IDC, but that number is predicted to reach $2.24 billion this year, a 60 percent increase.

“Therein lies the opportunity for someone like Dell,” O’Donnell said.

EMC’s stock rose 4.7 percent to $27.18 Thursday, while VMware fell 5.8 percent to $77.31. Dell was taken private in 2013 in a leveraged buyout by founder Michael Dell and Silver Lake, an investment firm.

Dell made its name selling personal computers and servers, but these have become cheap, generic commodities with low profit margins. Hence the company is reinventing itself as a provider of high-end hardware and services to large enterprises. An EMC acquisition could instantly catapult Dell into the big leagues.

But IDC’s Nadkarni said that Dell doesn’t need all of EMC. He thinks Dell should seek an “a la carte acquisition” that would allow it to buy EMC’s most attractive components, like VMware and the flash array business, while leaving out the traditional storage business.

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“Dell would be better off buying only their high-growth segments,” he said.

Not necessarily, said O’Donnell. “The spinning-disk storage, even though it’s not growing as fast, it’s a huge revenue stream,” he said.

Owning it would bolster Dell’s status as a full-service computing giant, and a worthy rival to Hewlett-Packard or IBM.


Hiawatha Bray can be reached at hiawatha.bray@globe.com. Follow him on Twitter @GlobeTechLab.

Correction: An earlier version of this story contained the incorrect stock price for EMC.