On Wednesday after the close, shares of CA (NASDAQ:CA) soared some 18% after The Wall Street Journal reported that Broadcom (NASDAQ:AVGO) would acquire the company. Broadcom soon confirmed the $18.9-billion buyout, and its shares quickly plunged on the news.
With AVGO stock down almost 3% Wednesday and more than 16% in early Thursday trading, what should investors do?
While $18.9 billion is small potatoes compared to the massive deal AVGO was trying to leverage in its buyout of Qualcomm (NASDAQ:QCOM), it’s still a noteworthy tie-up given Broadcom’s $105-billion market cap.
AVGO-CA Deal
What’s the market saying when a stock tumbles ~15% following a deal announcement? It’s pretty clear it doesn’t like the company’s M&A move. It’s not that the deal was bad per se. It just doesn’t feel like the greatest tie-up.
CA isn’t a bad company, and Broadcom clearly has plans for the asset. AVGO paid 16 times next year’s earnings in the deal. Analysts currently expect CA to grow earnings by 7% and 3% this year and next, respectively.
Revenue growth had become stagnant, but it’s clear that AVGO sees CA as a possible cash flow machine. Management expects the deal to be accretive to earnings immediately after closing the deal, according to its investor presentation. Further, it expects the CA deal to drive its long-term EBITDA margins up to 55%.
Selling off certain CA assets that AVGO doesn’t want and boosting prices for existing CA customers should help. CA has a number of market-leading positions through tech, and its average service booking duration is in excess of three years. That helps with recurring, dependable revenue. Predictable revenue stream and cash flow is helpful to a company and its management.
Debt is one downfall to the deal, clearly, but opportunity cost is another. I don’t really want to flat out disagree with CEO Hock Tan, but it just seems like there were a lot of other deals AVGO could have struck. Don’t get me wrong; CA isn’t bad. It’s just not great.
Trading AVGO Stock
After Thursday’s thumping, AVGO stock trades at about 10 times this year’s earnings. Shares have become pretty cheap, even if it’s only expected to grow revenue 3.4% and earnings 2.4% next year. It also has a dividend yield in excess of 3.3%.
The analysts were out quickly with their take on Thursday. The consensus was mixed.
Wells Fargo and Bernstein upgraded AVGO stock to “Neutral” from “Underperform,” while Nomura analysts cut their price target from $250 to $225 and kept a “Neutral” rating. Longbow analysts went down from “Buy” to “Neutral,” and RBC went from “Top pick” to “Outperform.”
Overall, though, the price targets are still high relative to AVGO’s current price. RBC is looking for $300 instead of $330, while DA Davidson kept its buy rating and $300 price target. Even Nomura’s target cut down to $225 still implies decent upside.
At this rate, it seems like analysts are cautiously optimistic, while investors are trying to decide whether the valuation is compelling enough to step in right now.
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The bounce off ~$200 was sort of a sigh of relief for investors in AVGO stock. However, the breach below $220 was really discouraging. The next significant level is all the way down at $170, although I don’t expect to find AVGO down there. For those that did or are thinking about buying, they can use Thursday’s low of $197.46 as their max risk if they’re worried about more downside.
Over $220, and AVGO stock would look much better.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
