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Merger Monday Whats Got us Talking

Broadcom, Qualcomm, CA Technologies; Will they? Won’t they? They did, and they shouldn’t have.

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How to buy nothing with 19 billion dollars.

Broadcom, months after having their $117 billion offer for Qualcomm blocked by the CFIUS, has now rebounded and has agreed to buy CA Technologies for 18.9 billion. Just like most rebounds, it doesn’t turn out too well. The fact that Broadcom bought a company with such a slow growth rate shows just how much Donald Trump has curved their plans when blocking the Qualcomm deal. Donald Trump’s screwed over more of Broadcom shareholders than Jeff Immelt did to GE shareholders. However, the fact of the matter on this acquisition is this: trust Hock Tan. This man has built one of the strongest semiconductors companies over the years through M&A. His formula is simple: make large acquisitions and bring the margins through the roof.

The reason why we like this deal is because of our view of the overall market. We think the market is overpriced, and the CA deal is more of a value acquisition rather than a super expensive growth purchase. In theory, the market wanted Broadcom to make a deal in the highly concentrated and cyclical semiconductor space. But to the contrairy, They already were exclusively in the semiconductor sector, and this revenue concentration could hurt them if any downturn in semis appeared. CA Technologies software business will account for 25% of Broadcom’s new proforma revenue. These sticky revenues should steady the share price in any downturn of semis.

The one main problem is how this connects to there semi business, and what synergies come from this deal. This is probably the main reason for the sharp decline of the price on Thursday. However, Broadcom declined at the lowest point $17 billion. They paid $19 billion for CA. It’s astounding how much the market hated the deal to discount the price out of the market cap.

Maybe the only thing these two businesses have in common is their high margins. Also, CA has gross margins over 80%, and opens them up to a new vertical. In addition, Software is less cyclical, meaning that over the long term, it adds more earnings visibility.

Just a few months prior, Broadcom was prepared to offer over $100 billion in cash and stock to Qualcomm. Yes, it would have been transformative and would’ve created a semi powerhouse, but also would kill their balance sheet. With a smaller deal, Broadcom’s free cash flow can be more focused on returning cash to shareholders through dividend increases and share buybacks. With a valuation at 9x 2018 projected earnings with a modest growth rate, we think this could be a good buy the dip moment for this giant. 

Qualcomm- A gift from china?