Broadcom's $19 billion deal to buy 'unloved' CA Technologies shocked everyone and crushed the stock— here's what they could be missing (AVGO, CA)

Hock Tan Donald Trump

Broadcom's stock plummeted on Thursday following news of its $18.9 billion acquisition of CA Technologies.
While investors fled, analysts familiar with the companies aren't so sure that the deal is bad for Broadcom.
The bull case for Broadcom's acquisition is multi-faceted: Some analysts see cross-over between the two companies' product portfolios — particularly in mainframes, where Broadcom has a hardware footprint and CA Technologies has a software play.
Others see Broadcom as pivoting toward software in order to build out its portfolio the way a private equity firm might.

Broadcom's surprise $18.9 billion acquisition of CA Technologies, announced Wednesday, has caused a chasm on Wall Street as investors and company analysts try to figure out whether or not the deal is a good thing.

Broadcom's share price sunk 14% Thursday following the announcement of the deal, a sign of investors' discomfort with the high pricetag and lack of clarity over what Broadcom, a semiconductor company, plans to do with what some see as an underperforming software company.

But not everyone is sour on the deal. While most analysts were surprised to hear of the acquisition, many think investors are missing the big idea behind Broadcom CEO Hock Tan's seemingly spontaneous purchase.

"While we do not think that anyone would have imagined this potential combination (definitely not us!), the deal does highlight the growing strategic importance of software to ‘non-traditional’ acquirers," Kirk Materne, an analyst with Evercore ISI, wrote Thursday.

Here's why analysts are keen on the deal, even if investors are not.

CEO Hock Tan has a record of successful acquisitions

Broadcom AVGO stock

One explanation for why Broadcom's stock fell so much on Thursday is that investors didn't understand the strategy behind the acquisition. But analysts don't necessarily see the obscurity as a bad thing.

One reason is that Tan, in his 12 years as CEO at Broadcom and its predecessor Avago, has made several acquisitions that turned out well for the company. Basically, many analysts trust Tan's judgement.

"We think the Street is completely misunderstanding the CA Technology deal," Harsh V. Kumar, an analyst with PiperJaffray, said in a note Thursday. "In our opinion, the CA product set is an extension into some of the Broadcom’s recent acquisitions (Brocade and LSI), ones that have worked well for the company."

Broadcom acquired Brocade in November 2017 for $5.5 billion. It bought LSI for $6.6 billion in December 2013.

UBS analyst Timothy Arcuri was less enthusiastic about the deal, and wrote that he finds "the strategic rationale here hard to see." But he agreed with Kumar that CA Technologies has similarities to the Brocade acquisition, in that is "ultimately a cash flow play" for Broadcom.

CA Technologies complements Broadcom's portfolio

Mike Gregoire CEO of CA Technologies While Broadcom's bread-and-butter semiconductor business has more obvious crossover with a company like Qualcomm, analysts see several areas where CA Technologies could boost Broadcom's profile — most notably in mainframe computers.

"Broadcom expects the acquisition will expand its position as a mission-critical technology provider," Credit Suisse analyst Brad Zelnick. "[Broadcom] can also realize synergies between its established enterprise customer base and CA’s Enterprise Solutions business."

Kumar similarly noted that Broadcom's hardware products like switches and boxes are sold into data center and mainframe environments, where CA Technologies has a strong software presence, both areas "with very few alternatives."

While Zelnick describes CA Technologies as an example of "unloved, value-oriented software stocks," that could change post-acquisition.

John DiFucci at Jeffries thinks the company could see a boost to its financials once some of its corporate overhead is gone, and that CA's operating margins could grow by at least 10% once it's eliminated administrative and R&D costs.

In any case, there's money in enterprise software

Whether or not Broadcom and CA Technologies converge product portfolios, some analysts think the real gold of the deal is that Broadcom now has a substantial foot in software.

Enterprise software companies, like CA Technologies, are extremely fragmented so there are many other small companies looking to be acquired.

Some analysts think Broadcom could take on the role of a private equity firm, and raise the value of smaller software units before selling then off for a profit.

"On the surface, this is a head-scratcher. But software is a fragmented sector w/ more assets than can be consolidated," wrote Arcuri. "When viewed through a Private Equity lens though, we see a possibility that
this could be the start of something bigger – perhaps a roll up of infrastructure software companies."

Materne highlighted AT&T's July 10 acquisition of the cybersecurity software company AlienVault as an example of unexpected software grabs from outside buyers.

DiFucci agreed that, if Broadcom did take a private equity approach and sell off CA Technologies down the road, it could see a pretty penny for its troubles.

"While it is difficult to see an exit strategy, the mainframe business can be milked for a very long time — providing a significant dividend to Broadcom — and the best of what is left might be able to be repackaged and sold as a rejuvenated new company via IPO or to another buyer," DiFucci wrote.

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