Tech Corner: VMWare Ahead of Earnings

              

Technology stocks and the market as a whole took a beating on Tuesday, of that there is no doubt. Unfortunately for the Select Sector SPDR Technology Fund (XLK: sentiment, chart, options), that heavy selling took the shares below the key long-term support I cited in last week's edition of Tech Corner - a development that could prove quite troublesome for the tech sector in the coming weeks. That said, there appears to be some strength emerging from the software sector on the heels of IBM's solid fourth-quarter earnings report. Two other key reports are looming just over the horizon in last year's dynamic duo, VMWare (VMW) and EMC Corp. (EMC).

Before we get into the particulars of these back-to-back reports, we should take a look at just where our tech barometer (the XLK) currently stands on the technical front. Putting it bluntly, the picture is not pretty, but there is hope. This week's early sell-off sent the trust below key support in the 23 region that had held since mid-November 2007. Not only did the XLK fail at this region, it plunged more than 13% on Tuesday before finding support at the psychologically significant 20 level.

The rebound from the 20 level was swift and strong, but even yesterday's buying mood - capped by a 600-point swing in the Dow - wasn't enough to boost the XLK above support-turned-resistance at the 23 level. This region is holding the trust lower in today's trading as well, despite strong earnings from QUALCOMM (QCOM) and Nokia (NOK). With this region establishing itself as overhead resistance, we could be looking at a sideways pattern for the XLK during the short term, which does not bode well for bullish technology investors at this point.

VMWare (VMW)

Earnings season is always a volatile time for equities on Wall Street. However, fourth-quarter earnings this time around appear to be doubly volatile, as investors are looking for any signs of a slowdown in companies forward looking statements. Apple (AAPL) can attest to the fact that it will take more than beating analyst expectations for the prior quarter, it will take at least flat-to-moderate growth to impress the Street. QUALCOMM's earnings report is a good example, as the company barely missed quarterly expectations, but boosted its 2008 revenue forecast -thereby placing itself above broader economic concerns that spoiled Apple's expectations for the year.

With the groundwork laid, VMWare (VMW: sentiment, chart, options) is scheduled to precede its former owner EMC Corp. (EMC: sentiment, chart, options) when reporting quarterly results. However, both reports will impact the same trading day of Tuesday, January 29. VMW releases its earnings report after the close on Monday, January 28, with analysts expectations encompassing a wide range of results. First Call sets the average estimate at 24 cents per share, while Zacks.com places the consensus estimate at 17 cents per share. Zacks.com also lists a range of estimates from 21 cents to 16 cents per share.

Historically, VMW is on firm fundamental footing, besting expectations for its prior report by 80%. Also working in the company's favor is that analysts have not had the opportunity to follow the company for very long, since VMW was spun off from EMC in the middle of last year. This means that analyst expectations could well be on the conservative side, making an upside surprise much more likely.

Since we know there are some likely bumps in the technical picture for VMW given the massive volatility this year, let's start with the sentiment backdrop and see what investors are thinking heading into the company's earnings report. Starting with analysts, it seems that Wall Street has lost some of its bullish stomach for VMW. Zacks.com reports that 8 of the 14 brokerage firms offering up a rating on the stock designate VMW a "hold." This bearish configuration leaves plenty of room for upgrades should the company surpass expectations once again in the earnings confessional.

Another area with sideline money potential is the short-selling crowd. Currently, a whopping 58% of VMW's float is sold short, and would take more than 6.5 days to buy back at the equity's average daily trading volume. With so many short positions levied against VMW, these bears could quickly find themselves in a short-squeeze situation on a positive reaction to next week's earnings. The end result of such a squeeze could quickly send VMW shares rocketing higher as this pessimism unwinds in added buying pressure.

Not everything is rosy on the sentiment front for VMW, however, as there could be several sticking points on the options front for the security. While the stock's Schaeffer's put/call open interest ratio (SOIR) has steadily risen from its January 10 reading of 0.59 to today's perch at 0.67, indicating growing pessimism ahead of the report, there is a wealth of overhead call open interest that could create trouble for VMW.

The shares are trading above the largest accumulation of call open interest for February at the 70 strike, but there is still heavy call open interest at the 80, 85, and 90 strikes in the February series of options. Remembering that overhead call open interest can create options-related resistance, VMW would need a post-earnings pop of more than 16% from its current levels in order to clear these hurdles in one swoop.

Looking at a technical chart of VMW, the hurdles at the 80 and the 85 are even more concerning for the stock. First, the 80 level is home to both the security's 10-day and 20-day moving averages, which have ushered the shares lower since mid-December. The 80 level is also home to long-term resistance/support for the shares, and could create a psychologically significant barrier to a weak rally following earnings.

The next technical hurdle is the 85 level, which is also home to prior support/resistance for VMW. Most recently, the 85 level rejected the shares on January 17, and has held the stock lower on a short-term basis since late December.

Sizing up the potential response next Tuesday by Wall Street, VMW jumped more than 10% on October 25 following the company's prior earnings report, which elicited several upgrades from the brokerage bunch. At the time, the company beat by 6 cents per share and chose not to give guidance for the fourth quarter or fiscal 2008. While the company will most likely best expectations this time around, such tight-lipped forward statements may hurt the shares. Still, a similar 10% move in the shares on Tuesday next week would put VMW solidly above resistance at the 85 level, and set the shares up for an extended run higher.

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