VMware just lost about $2 billion in value after a report said it wants to acquire its parent company

EMC Joe TucciEMCEMC CEO Joe Tucci

VMware shares dropped over 5%, or roughly $US1.9 billion in market cap, on Wednesday, following a news report that it could possibly buy out its parent company EMC.

According to Recode, VMware is looking at the option of buying out the 80% stake of its company owned by EMC, in a transaction called downstream merger.

The way it works is pretty complicated as it’s not a common merger deal. VMware would apparently issue new shares worth $US50 billion to $US55 billion, and then spend about $US30 billion worth of that stock to buy the 80% ownership EMC has. The remaining $US20 billion or so of shares will be given to current EMC shareholders. VMware was valued at about $US36.5 billion as of Wednesday’s close.

The report said the new downstream merger deal was proposed because VMware stock is currently valued higher than EMC’s in the public market. VMware’s 12-month forward looking price-to-earnings ratio, a metric used to gauge the company’s value relative to what it’s expected to make in the next year, is at about 18.99 versus EMC’s 12.85.

The combined entity would also help EMC reach its goal of saving $US850 million in annual expenses, the report said. It added there’s still a chance that the deal may not materialise at all.

EMC, best known for selling storage hardware, acquired VMware, a cloud virtualization company, for roughly $US625 million in 2003. Then in 2007, it sold about 15% of VMware in an IPO.

In July 2014, activist investor Elliott Management spent more than $US1 billion to take a 2% ownership of EMC, making it one of the largest shareholders of the data storage firm.

Since then, Elliott has pressured EMC to spin off VMware, arguing the move would boost both of their values, while also easing some of the competition in areas they’re both in.

EMC CEO Joe Tucci has consistently opposed a spin off of VMware in the past, saying the current structure creates more value.

EMC shares were up over 3% today.

EMC declined to comment, and VMware and Elliot Management did not immediately respond to our requests for comment.

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