Broadcom’s Decision to Acquire CA Tech Upsets the Market

Wall Street was not happy with Broadcom’s (NASDAQ:AVGO) decision to pay $18.9 billion for U.S.-based mainframe software maker CA Technologies (NASDAQ:CA). The 100% cash deal, which values CA at $44.5 a share, came just months after President Donald Trump blocked the company’s attempt to acquire Qualcomm (NASDAQ:QCOM) for $117 million on national security grounds. The chipmaker witnessed a 25% decline from its all-time high as investors did not appreciate the 20% premium being paid for the acquisition. 

Broadcom is looking to expand its addressable market beyond chips and into software, and it sees it reaching $200 billion from the current $65 billion owing to the deal. However, considering the fact that the two businesses are operating in different segments, analysts are questioning the probability of cost synergies being realized. 

For a company that has recently moved its headquarters to the U.S. and suffered a failed acquisition attempt with Qualcomm, management’s idea to portray it as an organically growing company seems to be going haywire. Analysts on the Street are arguing that the company’s attempt to foray into a segment with absolutely no connection to the semiconductor industry is a risky bet, given the fact that Broadcom has no operational expertise in improving CA’s operations. ”Management has stressed that Broadcom is focused on delivering shareholder value through organic growth, capital return, and tuck-in acquisitions,” said Nomura analyst Romit Shah (Profile & Recommendations). “This deal hurts management’s credibility, in our opinion.”

Coming to insider opinion, the management is quite bullish on the deal, with Hock Tan, President and CEO of Broadcom stating,“This transaction represents an important building block as we 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 to our portfolio of mission-critical technology businesses.”

Unfortunately, analysts don’t share the same optimism. Mizuho’s top analyst Vijay Rakesh (Profile & Recommendations) stated, “From the investor point of view, this (CA acquisition) makes modeling much tougher and more difficult to pinpoint where the next upside or downside is coming from. Investors feel CA has not really grown for many years and is dampening AVGO topline outlook from L-T 4-5% growth to 3% growth. While AVGO could now become a rollup vehicle for both semiconductor and software names, we believe it could remove focus on execution.”

The primary reason for the doubt among the investor community is that at a time when everything is moving to cloud computing, Broadcom made a bid to acquire a mainframe software company. Moreover, after the Qualcomm deal tanked, investors are not expecting government intervention with this deal, given the fact that it’s tough to pin-point an explainable reason for the acquisition, which Broadcom says is to keep acquiring mission-critical tech businesses to become a market leader in the tech space. 

“Legacy software assets are highly tangential to Broadcom’s core data-center and smartphone chip businesses. Integration here would likely be harder and customer bases have little overlap,” Bloomberg analyst Anand Srinivasan stated. 

Nonetheless, from a long-term perspective, analysts are more bullish on the stock. Per the TipRanks analyst consensus, Broadcom currently floats a Strong Buy rating. Out of the 31 analysts surveyed in the past 3 months, 24 have a buy rating while only 7 have a hold rating. Meanwhile, the price target on the stock is currently $300.04, with the high estimate reaching $350 and low estimate being $220, indicating a 42.65% upside from current levels. See what other Top Analysts are saying about AVGO.

All told, the stock does have strong fundamentals when looking at it as a long-term investment. With tax reform providing a huge one time boost to its bottom line and past mergers providing cost synergies, the company has seen a tremendous increase in its margins. Moreover, Broadcom’s primary revenue driver is its data centers, which are forecast to grow to a $356 billion market by 2019, per a Gartner report. Having said that, at a P/E ratio of 8.3 the stock seems to be grossly undervalued at the moment when compared with the S&P 500’s 24.27. 

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