August 9, 2019

Breakingviews: Latest Broadcom deal combines two bad ideas in one

by Breakingviews.

Broadcom’s latest deal combines two bad ideas in one. The acquisitive chipmaker, finding few rivals worth snapping up, has moved to the fresher fields of business software. Spending almost $11 billion on Symantec’s enterprise-security unit expands its addressable market by $161 billion, according to the company. But M&A machines often sputter, and buying vaguely related businesses raises the odds of failure.

Boss Hock Tan figured out early on that he could keep growing earnings in a maturing semiconductor industry by using acquisitions to boost revenue and to cut costs. That strategy prompted a 15-fold increase in Broadcom’s stock price over the past decade.

Yet with a market value of some $108 billion, it’s harder to find large enough deals to keep the company’s engine running. The Trump Administration blocked its $117 billion attempt to buy Qualcomm last year. A recent slowdown in semiconductor growth – Broadcom slashed its annual revenue forecast by $2 billion in June – may mean it’s better to postpone chip purchases, given the industry’s notorious cyclicality.

So Tan has pivoted. A year ago, it purchased business-software provider CA for $18.9 billion. Investors didn’t like it, taking nearly $16 billion off Broadcom’s value on the news. Since then, the stock has more than recovered as investors warmed to the idea that companies are reluctant to ditch software they’re familiar with. So an acquirer can often squeeze costs or raise prices without customer flight.

Revenue at Symantec’s enterprise unit has shrunk 9% over the past four quarters, during which time the division only threw off $269 million of operating income. Tan thinks he can find over $1 billion of expenses to slash within a year. If so, the return on investment will be nearly 10%. Yet the synergies are equal to about half of the unit’s operating costs last year, meaning Tan’s cuts could do more harm than good.

History shows it’s difficult for acquisition machines to sustain success. In 2015, James Litinsky of JHL Capital pointed out that these firms often overpay, have trouble integrating what they buy, and that cutting expenses such as R&D can backfire. Of the 24 companies he named, two-thirds have since suffered a drop in market capitalization, many by more than half. Only a handful outperformed the S&P 500 Index. Broadcom is one of them. Tan’s expansion into an industry that is only vaguely related to its chipmaking core may put that at risk.


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