Why Broadcom Already Should Ditch Its Planned CA Acquisition

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It is no big secret that semiconductor companies all up and down the supply chain have been and would like to keep merging into larger and stronger companies so that their future cannot be broken by just one major customer. Broadcom Inc. (NASDAQ: AVGO) was hoping to acquire Qualcomm Inc. (NASDAQ: QCOM) in a deal that faced more scrutiny and reviews than most companies would be able to stand. Now that the Qualcomm issue is believed to be behind Broadcom, the company has decided that CA Inc. (NASDAQ: CA) was going to be a suitable quasi-replacement deal for the chip giant.

Based on what has been seen so far, Broadcom made a serious mistake in trying to acquire CA for a sum of roughly $18.9 billion. Broadcom shares were last seen at $209.50 with a market cap of almost $88 billion. The problem here is that the share price was almost $250 before the deal was announced, so it has lost almost 20% of its value even before the investment community has been able to react to the deal.

It is not unusual for an acquiring company to see its shares drop on news that it is making an acquisition. Sometimes the acquirer’s stock even rises. But this loss in market capitalization is almost the entire value of the CA transaction.

In short, Wall Street does not believe that Broadcom’s deal is the right one. Perhaps the only good news is that Broadcom’s shares traded up from the post-announcement closing low of $202.46. To make matters worse, Broadcom shares are now down over 25% from their 52-week high.

24/7 Wall St. has tracked multiple analyst calls regarding the Broadcom-CA deal and the vote is almost unanimous: Broadcom’s move to buy into business software should bring up questions about how solid Broadcom’s core semiconductor business is. Multiple analysts have downgraded Broadcom since the deal was announced a week earlier.

On July 18, Broadcom was downgraded to Neutral from Buy and the price target was cut to $220 from $300 at Goldman Sachs. The shares had closed up 2.5% at $208.31 on Tuesday, in a 52-week range of $197.46 to $285.68. Goldman Sachs analyst Toshiya Hari sees an increased uncertainty about the company’s strategic focus after the CA deal. Will Broadcom now try to become more of a software company over the longer view? How sustainable is its core chip operation on a competitive basis?

On July 16, Merrill Lynch rated Broadcom only as Neutral, with a mere $240 price objective.

On July 13, BMO Capital Markets downgraded Broadcom to Market Perform from Outperform with a $230 price target.

On July 12, several downgrades and target cuts were seen: Evercore ISI to In-Line from Outperform with a $275 target, RBC Capital Markets to Outperform from a Top Pick but still with a $300 target, and FBR to Neutral from Buy with a $245 target.

Other notable analyst and research calls in the wake of the CA deal were seen as follows:

  • Standard & Poor’s placed Broadcom’s corporate credit rating on CreditWatch Negative, a review for a downgrade ahead.
  • Nomura/Instinet maintained its Neutral rating but lowered the Broadcom target to $225 from $250.
  • Macquarie also downgraded Broadcom to Neutral from Outperform.
  • Raymond James downgraded it to Outperform from Strong Buy.

In an effort to show both sides of the coin, 24/7 Wall St. also included two research note summaries that were supportive of the Broadcom-CA merger.

Independent research firm Argus reiterated its Buy rating and $300 target, noting for shareholders to buy on the CA deal-weakness. The firm’s view was that there is potentially logic in the deal that may not be easily realized. CA’s enterprise IT applications and DevOps eventually may enable Broadcom to better target opportunities in cloud data center. Also noted was that this $19 billion purchase of CA would be a smaller bite than the prior planned $117 billion of Qualcomm, which would have also represented a doubling-down in the mobile device market that is already showing signs of saturation.

CFRA (S&P) reiterated its Strong Buy rating, and the firm has a $282 price target for Broadcom. The firm said in its view:

Our Strong Buy primarily reflects valuation and potential earnings leverage. We expect the pending acquisition of CA, Inc. to be immediately accretive and support margin expansion, but acknowledge CA reduces Broadcom’s growth trajectory. While we would rather see Broadcom expand its scale/addressable market via semiconductor deals, we like the added diversification and recurring revenue streams that CA has to offer. We have high confidence in management execution and view Broadcom shares as being extremely undervalued. We expect Broadcom to benefit from a favorable data center landscape and greater content per device gains within wireless. We see 5G representing an enormous opportunity for Broadcom in the coming years. We like Broadcom’s 3% plus dividend yield.

Broadcom is already an amalgamated semiconductor and equipment giant. The company only just recently has relocated its corporate flag to the United States. While the company is the combined Broadcom-Avago, it also recently acquired Brocade Communications Systems in a deal valued at more than $5 billion. If a $100-plus billion of Qualcomm was out of reach, it’s not all that shocking that a $19-billion deal to diversify operations has seen such an unenthusiastic reaction by the investment community.

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