Financial broker Morgan Stanley has questioned VMware's ability to meet its fourth quarter revenue numbers, after a turbulent 12 months for the virtualisation giant that saw the ousting of its co-founders, and a massive decline in its share price.

The company is due to report its fourth quarter and year-end figures at the end of January, but despite a string of healthy trading figures, Wall Street seems to have fallen out of love with the virtualisation vendor. Other investors are becoming openly cautious about VMware, a point highlighted in a blog by Zachary Scheidt, a managing general partner for a private hedge fund.

Scheidt pointed out that last month Morgan Stanley issued a "sell" recommendation on VMware's shares. UBS followed suit and also rated the virtualisation software vendor as a sell.

"On November 4th we initiated an RTI (Research Tactical Idea) for a trading sell on VMW, and now see further risk near term," said Morgan Stanley in its latest research note on VMware. "First, Q4 is off to a slow start and we believe VMW may struggle to hit consensus. Second, ELA (VMware's Enterprise License Agreement) momentum is slowing, which likely removes a major driver of license growth. Third, headcount will weigh on margins in the first half of 09."

"Now, I don't always put too much credence in recommendations from brokerages, but since sell ratings are so rare, I thought it worth a look," said Scheidt on his blog. "Upon further review, there were some very interesting red flags raised that indicate caution is still important with this name," he wrote.

Scheidt highlighted the disastrous slide of VMware's shares over the past 14 months. Shares in the company are currently trading at the $24.50 (£16) mark, a far cry from the heady heights of $122 (£82) reached in November 2007.

Nobody is suggesting that VMware will go bust. Indeed, quite the opposite as it continues to lead the virtualisation market, with more than 78 percent market share. However, with the entry of players such as Citrix and Microsoft, and other vendors such as Parallels, VMware is no longer the only fish in the pond.

Revenues for the third quarter were $472 million (£319 million), an increase of 32 percent from the third quarter of 2007 when it posted sales of $357.8 million. Net profit rose to $83.3 million from $64.7 million in the third quarter of last year.

But Scheidt picked up on Morgan Stanley's concern that VMware will have a difficult time meeting its fourth quarter revenue numbers. This is because as early as November, the "channel checks" that analysts undertake have suggested weakness in the sector.

There is also concern that VMware has been pushing its Enterprise License Agreement (ELA), which requires a much bigger commitment from customers, which in turn means that decision making will be stretched out as companies take longer to evaluate the agreement.

"Our conversations suggest that Q4 is off to a slow start, pricing is bad, the channel is starting to migrate towards MSFT (Microsoft) and large deal activity is slow," said Morgan Stanley.

Morgan Stanley is also concerned over the high numbers of staff at VMware, which it feels will impact profits in the year ahead.

"At the end of 2008, headcount will be 31 percent higher than the previous year and operating expenses will have grown a potential 43 percent. For a company that is having trouble estimating demand for its products, these rising expenses are alarming," Scheidt commented.

To be fair to VMware, in its third quarter filing it foresaw a difficult period ahead. "Current uncertainty in global economic conditions makes it particularly difficult to predict product demand and other related matters and makes it more likely that VMware's actual results could differ materially from expectations."

But VMware had enough confidence to maintain its 2008 revenue guidance for annual growth of 42 to 45 percent over 2007. "VMware cautions of an increased likelihood that 2008 revenue will be at the lower end of the guidance range." Morgan Stanley disagrees.

"We have gotten a number of negative data points on Q4, which is more back end loaded than normal. Deal cycles are longer, pricing is getting worse, and we are lowering our below consensus estimates from $510m to $500m," it said.

"As a matter of policy, we don't comment on stock price fluctuations," said Reza Malekzadeh, EMEA Senior Director of Products and Marketing at VMware. "But what I can say is that the fundaments of the business are sound."

"We are very mature software company and some quarters are more back end loaded than others," he said. "I would say that we have the same (financial) rhythm as other companies."

"But it is unprecedented times we are currently in, and it would be foolish of me to say it is not affecting us, like other companies," he said.

"That said, it is important to differentiate the stock market performance from performance of the company," Malekzadeh told Techworld. "These are tough times, but we have great technology, great alliances, and great customer adoption."