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Shares of EMC Corp (EMC - Analyst Report) surged on rumors of a spin-off of its virtualization software unit, VMware (VMW - Snapshot Report). However, nothing was confirmed by EMC regarding the same. EMC shares rose as much as 5.0% ($1.35) to reach a 52-week high of $28.37 on Jul 21, 2014.

Per reports, activist investor, Elliott Management Corp. has built up a stake in EMC worth $1.0 billion with the intention of pushing EMC for a probable spin-off of VMware. Elliott’s stake accounts for nearabout 2.0% of EMC’s shares, thus making it one of the five biggest investors.

Elliott Management Corp often resorts to an activist approach of investing, frequently amassing significant stakes in distressed or underperforming companies in an attempt to prompt a change.

The hedge fund had targeted many companies in the past ranging from oil producer, Hess Corporation to BMC Software and Juniper Networks (JNPR - Analyst Report). Per sources, Elliott intends to spin-off VMware from EMC since it believes that this will boost EMC’s currently lagging share prices.

Per sources, in an effort to convert these rumors of a spin-off into reality, Elliott has even given EMC’s Chairperson, who is expected to retire in 2015, the option to continue his services, provided the spin-off takes place.

EMC has a federal business structure comprising three segments including EMC Information Infrastructure, Pivotal and VMware. EMC’s data storage business (69.5% of revenues) has been struggling since the advent of cloud storage technology.  Revenues increased a meager 4.5% year over year to $16.13 billion in 2013.

In comparison, VMware (22.2% of revenues) revenues jumped 15.0% year over year to $5.15 billion. Moreover, EMC’s core operating income increased 7.1% year over year in 2013. On the other hand, VMware operating income jumped 27.1% year over year in 2013.

In such a scenario, we believe that the spin-off of VMware will adversely affect EMC’s overall results. We also believe that the increasing activism from Elliott can push EMC management to further increase its stake at VMware, which is the fastest growing business of the company.  However, given the past success rate of Elliott’s activism nothing conclusive can be said at this point of time.

We believe that EMC’s second quarter result will be significantly decisive in this regard. A better-than-expected growth from the core business will help the management to take concrete decision over Elliott’s activism.

Nonetheless, increasing competition from the likes of IBM and Hewlett Packard (HPQ - Analyst Report), and a sluggish IT spending outlook for the next two years will continue to keep margins under pressure in the near term.

Currently, EMC has a Zacks Rank #3 (Hold).

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