Shares of Broadcom Limited (AVGO - Free Report) tumbled about 17% in early morning trading Thursday after the chip manufacturer announced the surprise acquisition of CA Inc. in a deal valued at $18.9 billion.
Broadcom will pay that sum in cash for CA, a designer of mainframe software based in New York City. The purchase comes just months after President Trump blocked the chip giant’s proposed $117 million merger with Qualcomm Inc. (QCOM - Free Report) .
Initial reactions to the Broadcom-CA deal are rife with confusion, as analysts and investors alike appear to be struggling to find a rationale for the semiconductor company’s sudden interest in the software space.
“We think investors will likely be disappointed at this deal, which seems more financial engineering/PE driven than due to any strategic rationale,” wrote analyst from Evercore in a note Thursday morning.
CA’s primary business is selling software for massive, mainframe computers, and admittedly, Broadcom will now be a major competitor in that industry. Its new acquisition is second only to IBM (IBM - Free Report) in the mainframe software business, and the firm generates a healthy $10 billion in annual cash flow from its operations.
Still, some analysts have already pointed out that such a major bet on mainframe computing makes little sense in a world where customers are choosing cloud services over old-school hardware.
“While CA is a departure from Broadcom's core semiconductor business, it is consistent with its track record of acquiring out-of-favor, market leaders with high cost structures,” said Jefferies analysts. “Importantly, AVGO has consistently demonstrated its ability to drive costs down and margins of its acquisitions up, often measured in 1,000s of basis points.”
This sentiment from Jefferies is in harsh contrast to what some optimistic investors might point to right now: the ambition of Broadcom chief Hock Tan.
Tan has helped grow the company from a relatively minor chipmaker to a worldwide titan through a number of hopeful deals, and the executive as earned the respect of many on Wall Street. Still, today’s move has brought out the most skeptical of voices.
Investors have other reasons to be skeptical too, with Broadcom shares effectively flat lining over the past year despite sizeable gains for others in the semiconductor industry.
What’s more, analyst sentiment was already mixed heading into today’s announcement. The firm’s current fiscal year ends in October, and looking ahead, analysts appear uncertain as to what fiscal 2019 holds for Broadcom.
Over the past 60 days, AVGO has witnessed nine positive revisions to its fiscal 2019 earnings estimates, but five negative revisions have also come in during this stretch. The Zacks Consensus Estimate for fiscal 2019 has gained in the trailing two months but is down from where it started the current quarter at.
This mixed revision activity has kept Broadcom at a Zacks Rank #3 (Hold) for now.
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