Some big M&A news was announced last night after
the close. Broadcom (AVGO 208.57, -34.87, -14.32%), which makes semiconductors, is acquiring CA
Technologies (CA), one of the world's largest providers of IT management
software. The deal has been approved by the boards of directors of both
companies. CA's shareholders will receive $44.50 per share in cash,
representing a 20% premium from yesterday's close. The deal is expected to
close in calendar 4Q18.
Just to step back a bit, Broadcom primarily makes semiconductors that focus on connectivity (Wi-Fi, Bluetooth and GPS connectivity in smartphones). AVGO serves four primary end markets: wired infrastructure, wireless communications, enterprise storage, and industrial & other. Applications include data center networking, home connectivity, set-top box, broadband access, telecom equipment, smartphones and base stations, data center servers and storage, factory automation, power generation, and alternative energy systems.
CA Technologies, meanwhile, provides a broad range of software planning, development, and management tools. More specifically, its software helps customers with application development, infrastructure management, automation, and identity-centric security. These products are designed for mobile, cloud, and distributed computing environments. CA also has a Mainframe Solutions segment which focuses on the IBM z Systems platform. CA provides DevOps tooling and processes, increasing reliability and availability of operations through machine intelligence and automation. CA also has a Services segment to help customers implement CA software.
At first glance, the combination seems a bit odd, as this is an entirely new area for AVGO, and that probably explains why AVGO is trading so much lower on this announcement. However, AVGO notes that the deal will create one of the world's leading infrastructure technology companies. With its sizeable installed base of customers, CA is uniquely positioned across the growing and fragmented infrastructure software market, and its mainframe and enterprise software franchises will add substantially to AVGO's technology businesses. A key benefit to AVGO is that CA provides a large amount of predictable and recurring revenue, with the average duration of bookings exceeding three years.
Another positive is that this transaction is expected to drive Broadcom's long-term Adjusted EBITDA margins above 55% and to be immediately accretive to Broadcom's non-GAAP EPS. On a combined basis, Broadcom expects to have LTM non-GAAP revenue of approximately $23.9 bln and adjusted EBITDA of approximately $11.6 bln.
This deal comes just a few months after AVGO's failed bid to acquire Qualcomm (QCOM), although this CA deal, while still large ($18.9 bln), is much smaller than the QCOM deal would have been ($100+ bln). Also, this deal should encounter much less regulatory scrutiny than the QCOM deal.
In sum, AVGO is trading sharply lower on this announcement which leads us to believe the market is questioning the strategy here. And so are we. This selling appears to be related to questioning AVGO's strategy here and not so much concerns with the price being paid. This is a whole new area for AVGO, and the synergies do not seem obvious to us. It's almost as if AVGO is acquiring CA for its recurring revenue stream. Usually when deals like this happen, the goal is that there are clear synergies and cross-selling opportunities that result in a more valuable company together vs the sum of the parts. That is not currently obvious to us, but we shall see in time whether those synergies become emergent. Another concern is that AVGO plans to fund the purchase primarily with newly issued debt, which will leverage up the balance sheet.
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