A Potential Broadcom Bid for VMware Has Wall Street Mostly Upbeat

A Broadcom chip.

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Broadcom President and CEO Hock Tan in recent years has made a series of moves to expand the chip company’s business beyond semiconductors into enterprise software. In 2018, the company paid $18.9 billion in cash for the mainframe software provider CA Technologies, originally known as Computer Associates. A year later, Broadcom paid $10.7 billion in cash for Symantec ’s Enterprise Security software unit. 

Now Tan apparently is upping the ante: according to The Wall Street Journal, Bloomberg, and other outlets, Broadcom (ticker: AVGO) is in advanced talks to buy enterprise-software company VMware (VMW). The Financial Times reports that the deal could be worth more than $50 billion to VMware holders, which implies a valuation north of $115 a share. The deal would roughly triple the size of Broadcom’s software business.

VMware is a leader in server-virtualization software, and it has a large position in the market for hybrid cloud infrastructure, making it easier for large businesses to manage data and content on multiple cloud-computing platforms. Until late last year, the company was majority controlled by Dell Technologies (DELL), which received the stake in 2016 through the acquisition of enterprise-storage business EMC. In November, Dell distributed its stake in VMware to Dell holders. That includes Dell CEO Michael Dell, who now holds a 42% stake in VMware. 

VMware shares have been under pressure since completion of the deal, largely reflecting the widespread reset of technology-stock valuations, although VMware has also struggled with a shift in its business model to a cloud-based model from on-premise software offerings. VMware shares closed at $134.87 on the day after the completion of the spin from Dell; the stock hit a postdeal closing low of $93.63—a decline of 30%—just last week. The reported deal price of $115 a share would be a 15% discount to the post-spin share price.

Analysts seem generally supportive of the potential merger, and see few obvious obstacles to completion of a Broadcom/VMware deal. For one thing, shareholder approval should not be an issue, given Michael Dell’s substantial stake, and another 11% block controlled by the private-equity firm Silver Lake.

KeyBanc analyst Thomas Blakely writes in a research note that “the deal should be relatively easy to close,” given previous regulatory approval to Broadcom’s other software deals. Blakely also writes that while he finds it unlikely that another strategic suitor appears, considering VMware’s modest valuation, a buyer with an eye on reselling later could emerge. He notes that VMware trades at about a 25% discount to its three-year acreage multiple on next 12 months Ebitda, or earnings before interest, taxes, depreciation, and amortization.

Citi chip analyst Christopher Danely, while maintaining a Buy rating on Broadcom stock, cautions that an acquisition of VMware could trigger a selloff in the chip maker’s shares, given that VMware’s operating margins are less than half of Broadcom’s.

But New Street Research analyst Pierre Ferragu writes that VMware is an “ideal target for Broadcom’s playbook,” cutting costs to boost profitability. He thinks Broadcom would cut VMware’s selling, general, and administrative expenses by two-thirds, in line with past acquisitions, while maintaining research-and-development spending, with a focus on its core platforms. Ferragu and others note that the company isn’t likely to pay all cash, given the substantially higher leverage that would require; he thinks a 50/50 cash and stock deal is more likely. He thinks a deal could be 15% accretive to Broadcom’s earnings per share.

Stifel analyst Brad Reback is supportive of the deal as well, asserting that the combination “makes sense on many fronts.” Under Broadcom’s control, he writes. “VMware will likely be much more profitable, less dependent on top-line growth and have less pressure to accelerate its ongoing shift to a SaaS [software-as-a-service] model.”

Neither company has commented on the reports.

VMware is expected to report April quarter earnings on Thursday. The company has projected revenue of $3.185 billion, up 6.5% from a year ago, with non-GAAP profits of $1.56 a share. Street estimates are about in line with guidance.

On Monday, VMware shares have rallied 21%, to $115.90, increasing the company’s market cap to $48.7 billion; including about $9 billion in net debt, the enterprise value of a deal at this price would be about $59 billion. Broadcom shares are down 2% on the news.

Write to Eric J. Savitz at eric.savitz@barrons.com