By Xunliang Huang (University of Melbourne), Sameer Jain and Micheal Akullo (Wharton School)
Photo: Sigmund (Unsplash)
Overview of the deal
Acquirer: Broadcom Inc.
Target: VMware, Inc
Total Transaction Size: $61bn
Closed date: Expected sometime in FY23
Target advisor: Barclays, BofA Securities, Citigroup, Credit Suisse, Morgan Stanley, Wells Fargo Securities
Acquirer advisor: Goldman Sachs, J.P. Morgan
Broadcom Inc. (NASDAQ: AVGO) announced earlier this year its definitive agreement to acquire VMware (NYSE: VMW) for approximately $61 billion. A long time microchip powerhouse, Broadcom is now seeking to enter the corporate software space via its tried-and-true strategy of acquiring deeply rooted and sticky IT servicers, cutting costs, and aggressively cross-selling.
The size of the deal implies a per-share value of $138, which represents a more than 40% premium over VMware's stock price prior to the announcement. Half the purchase will be financed with cash and the remainder with stock, and Broadcom would also be assuming $8 billion of VMware’s outstanding debt. The deal could potentially draw regulatory scrutiny depending on the perceived boost to Broadcom’s already substantial pricing power.
The deal would nearly triple the size of Broadcom’s software business, and double the combined company’s revenues. Broadcom’s management is attracted to the mission-critical nature of VMware’s offering and sees the deal as a way to broaden its base of blue-chip clientele and its portfolio of highly demanded services amid short-term tumult in the industry.
“Building upon our proven track record of successful M&A, this transaction combines our leading semiconductor and infrastructure software businesses with an iconic pioneer and innovator in enterprise software as we reimagine what we can deliver to customers as a leading infrastructure technology company” - (Hock Tan, President and CEO of Broadcom)
Company Details (Acquirer - Broadcom)
Broadcom is a designer, manufacturer, and supplier of a wide array of semiconductor and infrastructure software products. Its semiconductor products are primarily communicational, and service needs related to data/server storage, networking, and broadband. The software business is focused on developing enterprise solutions for creating, managing, and securing complex digital environments. The company is most recently the result of Avago’s 2015 acquisition of Broadcom Corporation.
Founded in 1961, headquartered in San Jose, California, USA
CEO: Hock E. Tan
Number of employees: 20,000
Market Cap: $226.5bn (as of 24/11/2022)
EV: $244.2bn
LTM Revenue: $31.7bn
LTM EBITDA: $18.0bn
LTM EV/Revenue: 7.7x
LTM EV/EBITDA: 13.6x
Company Details (Target -VMware)
VMware is a US-based cloud computing and virtualization technology company. With its IPO on the NYSE in 2007, VMware successfully boasts a leadership position in the international infrastructure and business mobility space with LTM revenue of $12.9 billion and is experiencing stable growth, with YoY revenue growth of 9.2% between FY21 and FY22. VMware’s main product offerings include a comprehensive range of desktop software, server software, and cloud management software for businesses to provide an integrated approach to improve technology usage.
Founded in 1998, headquartered in Palo Alto, California, USA
CEO: Rangarajan Raghuram
Number of employees: 31,000
Market Cap: $50.7bn (as of 24/11/2022)
EV: $59.3bn
LTM Revenue: $12.9bn
LTM EBITDA: $2.3bn
LTM EV/Revenue: 4.6x
LTM EV/EBITDA: 25.4x
Projections and Assumptions
Short-term consequences
The successful closing of this deal would create a combined company with double the annual revenues of Broadcom. The size of the deal and the involvement of Broadcom, whose growing pricing power has previously elicited attention from the FTC, mean regulatory roadblocks are a possibility. However, the nature of this deal, like others in Broadcom’s past, is largely financial rather than an attempt at horizontal consolidation. Despite its identity as a semiconductor player, the company’s largest acquisitions historically have been focused on software, and the strategy has revolved around intense cost-cutting and cash flow optimization rather than R&D synergies and technological breakthroughs.
The deal will provide a welcome cushion to Broadcom given the headwinds facing the tech industry in the near term, as IT spending is projected to grow at a healthy 4% this year, with cloud technologies expected to outperform the overall sector. It is also likely to mark a substantial shift in Broadcom’s overall brand identity, with the case for marketing itself as primarily a chip company growing less meaningful given just how large a chunk of overall revenues will now come from the combined software business. This acquisition is largely a bet on the belief that wrapping together disparate service lines and pursuing aggressive cost-driven margin expansion and cross-selling is a strategy capable of delivering outsized returns. CEO Hock Tan has executed well on this strategy so far. An attempt to do so in this uncertain macro environment will be a test of the strategy’s long run resilience.
Long-term Upsides
If the transaction concludes successfully by fiscal year 2023, Broadcom-VMware will achieve a broader coverage in tech, in its existing semiconductor hardware industry and software integrations with the aid of VMware. Together, Broadcom CEO Hock Tan expects successful creation of multi-cloud app deployment and management offered by VMware for enterprises. Post acquisition, the strategic part of the VMware software portfolio, Tanzu, will remain unchanged as it is the critical component of VMware for their customers. As a result, with implementations of Tanzu, Broadcom expects 49% of the company’s combined annual revenue coming from enterprise software sales catering for the need of multi-cloud based IT enterprises.
Tan’s strategy moving forward is to increase customer’s willingness to pay through research and development, and create value by designing a full portfolio of innovative product offerings. Broadcom aims to bring customers greater flexibility and deliver new solutions to help them “connect, scale, and protect their IT infrastructure”, says Tan in the Broadcom Blog published in October 2022.
Tan also has ambitions towards creating sovereign clouds for customers. As the world’s governments increasingly recognise the power of data to drive economic activities, Broadcom views cloud sovereignty with great potential moving forward. A sovereign cloud would give greater interoperability and control over their data for enterprises and governments. If Broadcom can capitalise upon the demand for sovereign cloud and adopts a leadership position in its implementation with the aid of VMware, contracts with enterprise clients and governments can be expected, giving rise to high quality cash flows for Broadcom.
Risks and Uncertainties
There are many factors facing the merger between Broadcom and VMware. One such aspect is the huge employee turnover expected at VMware as existing employees start to leave the company due to the potential transaction. Whilst some worry about the upcoming changes due to the acquisition, others are reluctant to return to the office as Broadcom CEO Hock Tan reduces opportunities to continue working remotely post-covid. As of today, VMware has already lost seven important executives, of which four only joined in January 2022. If VMware fails to retain its power players during the upcoming phase of transition, remaining employees, clients, and management may experience anxiety and pessimism about the future of VMware.
Furthermore, the $61bn transaction is also subjected to UK competition regulator’s scrutiny as the post-forma company may substantially lessen competition. The CMA (Competition and Markets Authority in UK) has launched an investigation into the acquisition and invited interested parties to submit comments in the preliminary phase one investigation, with a meeting to be conducted in December 2022 - eight months following the deal’s announcement in May 2022. However, Broadcom remains confident that “the deal does not present any competition issues”, and that “[VMware and Broadcom] are making progress with various regulatory filings around the world and expect the transaction to be completed in Broadcom’s fiscal year 2023”.
“Once we complete our transaction, I look forward to starting the important work of fostering an environment of growth and innovation aligned with our customers’ priorities.” - Hock Tan (President and CEO of Broadcom)