Don’t Buy Broadcom Stock Until This Weird CA Acquisition Shakes Out

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Broadcom stock - Don’t Buy Broadcom Stock Until This Weird CA Acquisition Shakes Out

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Until recently, Broadcom (NASDAQ:AVGO) CEO Hock Tan had the Midas Touch. Since taking the helm in 2006, he has proven to be a maestro at aggressive M&A dealmaking. The result is that he has created one of the world’s largest semiconductor suppliers. Yet lately things have gone haywire. Since early June, Broadcom stock has plunged from $270 to $202.

First there was Tan’s failure to acquire QUALCOMM (NASDAQ:QCOM). The $117 billion deal would have made Broadcom a semiconductor superpower, providing a treasure trove of patents and access to growth markets like automotive.

But of course, the Trump Administration blocked the deal because of national security concerns. There was the fear that Broadcom would hamper efforts for critical technologies like 5G.

Although, this was not the biggest issue. It was instead the follow-up – that is, the $18.9 billion proposed acquisition of CA Technologies (NASDAQ:CA). On the news, Broadcom got slammed (the performance was the worst in the company’s history).

The deal was, well, a head scratcher. Why is Broadcom doubling down on a the legacy enterprise software market?

According to analysts from Evercore, this was the headline: “What the Hock?” In it, they concluded: “We think investors will likely be disappointed at this deal, which seems more financial engineering/PE driven than due to any strategic rationale.”

Broadcom Stock and the Positives of the CA Deal

Now Broadcom’s deal for CA is not completely brain dead. Again, Tan has been adept at wringing out value from his deals, with tough cost cutting and unloading of divisions.

It’s also important to note that CA’s business is highly sticky and provides juicy recurring revenues. The reason is that the technologies are generally mission-critical (basically, there would mean quite of bit of disruption if they were replaced). After all, CA has been around since the mid-1970s.

The mainframe business also counts 92 of the top 100 banks in the world and 10 of the largest insurers.

From a financial standpoint, there are certainly positives for AVGO stock. The deal is expected to drive long-term adjusted EBITDA margins over 55% and be immediately accretive.

Bottom Line on Broadcom Stock

Despite the benefits, I still think the deal could pose serious challenges. The mainframe market is definitely not a growth market. However, this business accounts for a hefty 51% of the total revenues for CA.

Something else: CA faces fierce competition in other categories like security and DevOps. If anything, the deal could pose distractions for management and allow for fast-growing operators, like New Relic (NYSE:NEWR), to get even more momentum.

Yet the biggest issue is likely to be the lack of synergies. The deal will mean that 28% of overall revenues will come from software. True, chip manufacturing does involve software development, but it usually is a minor part of the overall process.

In other words, it will probably get tougher to manage the disparate operations of the combinedBroadcom-CA operation.

In fact, there are plenty of examples of how this diversification strategy can stunt growth. Just look at Cisco (NASDAQ:CSCO). After a buyout binge in the 1990s, the shares would then ultimately become dead money from 2001 to 2016.

Now this is not to imply we’ll see a repeat. But then again, it would not be surprising to see changing of the shareholder base as there will no longer be a pure-play on semiconductors.

And in the meantime, there will also likely be a wait-and-see approach on the benefits of the merger.

So for now, it’s probably best to wait on Broadcom stock.

Tom Taulli is the author of High-Profit IPO StrategiesAll About Commodities and All About Short SellingFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

Tom Taulli is the author of various books. They include Artificial Intelligence Basics and the Robotic Process Automation Handbook. His upcoming book is called Generative AI: How ChatGPT and other AI Tools Will Revolutionize Business.


Article printed from InvestorPlace Media, https://investorplace.com/2018/07/broadcom-stock-weird-ca-acquisition/.

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