Semiconductor giant Broadcom (AVGO - Free Report) has decided to buy mainframe and infrastructure software provider CA Inc (CA - Free Report) for $18.9 billion or $44.50 per share in cash, representing a 20% premium to the company’s closing price on Wednesday. Government approvals are pending.
Rationale for CA
CA hasn’t done so well in the last few years. Revenues have declined consistently between 2013 and 2016, more or less flat-lining last year and picking up in its fiscal 2018 due to the contribution from acquisitions. Gross profit shows a similar pattern. While the EBIT has picked up this year, the consistently rising interest and taxes have depressed its earnings performance.
The company intended to modernize its solutions by incorporating automation, data, analytics and security into its products through organic product development or acquisitions with a customer focus. It also recently announced a headcount reduction of 800 to align with its changing strategy. Since Broadcom is a master at integrations, it makes sense for the company to turn the reins over to somebody with more experience. So there’s good reason for CA shareholders to cheer, which they did, sending shares soaring yesterday, after the news broke.
What’s In It For Broadcom
Broadcom on the other hand is a semiconductor company that has mainly grown by acquiring companies in the same industry and then trimming them down to maximize efficiencies. There isn’t much in its past to suggest that it would head into software next. So investors are understandably concerned about how this integration will go and also, whether the company will succeed in its diversification-beyond-semis strategy. No wonder then that the shares plummeted following the announcement.
But there are some positives as well.
First, CA is in trimming mode, which works nicely with Broadcom CEO Hock Tan’s line of thinking. So some of the work that he would need to do is already being done.
Second, semiconductor deals of the kind Broadcom pursues are getting harder and harder to come by because of the significant amount of consolidation the industry has already seen. The current deals on the stage are very high-profile, intended to capture product roadmaps and including a higher element of risk. The payback period is also relatively more uncertain.
Third, software is the future. Even hardware companies generally have software integration units, but the way technology is advancing, software opportunities are opening up in every sphere of life as individuals, companies and other entities are all increasingly turning to the cloud with always-connected devices to store, process and retrieve their information that is then used in everyday decision making. For an acquisitive technology company to completely pass up this opportunity may not be such a good idea.
Fourth, CA’s mainframe business is likely to generate a steady flow of revenues with better visibility. The infrastructure market is big and expanding, so there’s room for multiple players to grow. Augmenting with other deals in the space could help Broadcom become an important player.
It’s a daring move for Broadcom, especially considering its unproven software capabilities and the price tag (roughly 4.5X its 2018 revenue). But the good thing is, it will be immediately accretive.
Another concern is whether Broadcom will be able to balance its cost-cutting itch with the need to invest resources in R&D because that is a software company’s life blood.
Whether it will succeed in this effort is anybody’s guess, but it’s a good time to try.
Both CA and Broadcom carry a Zacks Rank #3 (Hold). So better buys would be buy-ranked companies like Autohome (ATHM - Free Report) , TTM Technologies (TTMI - Free Report) , Intel Corporation (INTC - Free Report) and Cyberark Software (CYBR - Free Report) . Or you could also take a look at the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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