VMware bails on its 'head-scratching' plan to spin out a new company, and two board members quit

VMware has changed its mind and is not going to spin out a new cloud computing company called Virtustream with its parent company, EMC, after all.

VMware surprised everyone when it announced plans to create Virtustream in October, after Dell announced its complicated takeover of EMC, which would turn most of VMware's shares into a tracking stock.

Essentially, the plan was to take a company called Virtustream, which EMC bought last spring for $1.2 billion, add a bunch of VMware's cloud-computing products and services that overlap with Virtustream, and spin them out into a new separate company, also called Virtustream.

EMC and VMware were going to jointly own Virtustream, 50-50. But since EMC owns most of VMware, most of Virtustream would have wound up under Dell's control, assuming Dell's massive, $67 billion proposed acquisition with EMC goes through.

Mixed reviews from analysts

The problem is that this spin-out would have cost VMware dearly, says analyst Daniel Ives with FBR (who rates VMware stock Market Perform).

"Virtustream was going to result in a, roughly, $200 million to $300 million non-GAAP hit to the bottom line for VMware in 2016, and this remains one of the more 'head scratching' moves we have seen recently across the tech space," Ives wrote, as reported by Barron's.

Other analysts, like Abhey Lamba with Mizuho Securities, feel the opposite, believing that original plan to spin out Virtustream was "well-deliberated" whereas this decision to kill the spin-out "seems to be a reaction to the price action on the stock post the [Dell/EMC] announcement."

Lamba adds, "It is very difficult to have confidence in sustainability of management's decisions given the pressure from the needs of its largest shareholder; EMC currently, and Dell after the deal closes."

It seems like that pressure is continuing.

In addition to the news that VMware was bailing on Virtustream, VMware announced that two of its board members have quit: Pamela Craig (former Accenture CFO) and Dennis Powell (former Cisco CFO).

Meanwhile, the VMware board appointed an EMC board member to join them:Donald Carty, former CEO of American Airlines' parent company AMR.

While this whole Virtustream incident is a bit baffling, it leaves VMware with a serious problem. This was VMware/EMC's grand plan to compete with cloud computing vendors like Amazon, Google, and Microsoft, using EMC's hardware and VMware's software for that cloud.

Now, VMware needs to come up with a new strategy to get win with cloud computing, Lamba notes.

VMware says it will provide updated guidance when it announces its year-end results in January 2016.

Investors were not happy with the spin-out idea to begin with, though they also seem less than thrilled with this change of plans, too. VMware stock is down about 3% this morning. It has yet to recover from the dive it took when Dell announced its acquisition of EMC.