Vice President: Gordon So
Analysts: Pratyush Singh, Seun Adeleye, Riyaad Uddin, Manav Sood
Acquirer: Broadcom Inc.
Acquiree: VMware Inc.
Deal Size: $61 billion
Buy Side Advisors: Barclays, Bank of America Securities, Citigroup, Credit Suisse, Morgan Stanley, Wells Fargo Securities (financial), Wachtell, Lipton, Rosen & Katz, O’Melveny & Myers LLP (legal), Cleary Gottlieb Steen & Hamilton LLP (regulatory)
Sell Side Advisors: Goldman Sachs, J.P. Morgan (financial), Gibson, Dunn & Crutcher LLP (legal)
On 26th May 2022, software and semiconductor provider Broadcom announced the agreement to acquire American software company VMware in the TMT sector. The deadline for this deal is the 26th of May 2023 (1) (following a 3-month extension agreement made between the participating firms), and once completed, it will allow for a ‘combined company’ that serves the ‘different but important enterprise needs’ that both firms separately address – as president of Broadcom Tom Krause states (2). Totalling to $61bn, this deal sees Broadcom as the acquirer of VMware. Together, the two firms will be able to combine their assets and portfolios to provide more efficiency and innovation to their customers.
Broadcom is a global technology leader that designs, develops, and supplies a broad range of semiconductor and infrastructure software solutions, working in a range of markets like broadband, software, and wireless markets. Through this deal, Hock Tan, the president of Broadcom, argues the firm is expanding to improve their provision of leading infrastructure services by working alongside an innovator in enterprise software. Following the completion of the deal, the Broadcom Software Group will rebrand as VMware meaning the combination of both firms’ teams and assets will be ‘housed under the VMware brand’ as Raghu Raghuram, the chief executive officer of VMware, has stated.
Broadcom has a history of successful acquisition talks, having acquired notable companies such as Brocade Communications Systems (2017), CA Technologies for $19bn (2018) and Symantec Enterprise Security for $10.7bn (2019) (3). This track record suggests that the company is well-equipped to leverage the merger with VMware to efficiently grow and transition into a new sector. Furthermore, the strength of Broadcom is seen in their financials, for instance with their strong financial condition holding over $9bn in cash and rapidly growing net income.
VMware is a leading cloud computing and virtualization technology company (4), that specialises in developing virtualization software for running virtual machines off a single server (5). Over the years, it has evolved into a hybrid cloud and digital workspace leader. VMware has a history of successful deals, including its merger with EMC in 2016, which was worth $67bn and resulted in Dell receiving VMware (6). Consequently, Michael Dell, the founder of Dell, is currently the largest shareholder in VMware and serves as the chairman of the VMware board. Dell is optimistic about this deal and believes that Broadcom’s involvement will enhance the delivery of innovative solutions provided by VMware to enterprises worldwide (7).
Furthermore, the agreement includes a ‘go-shop’ clause, providing VMware with a 40-day period to seek out more valuable proposals from rival buyers to Broadcom. This gives the company an advantage and ensures that it secures the best deal possible.
The deal itself is a cash-and-stock transaction totalling to a value of $61bn, with Broadcom acquiring all outstanding shares of VMware. This figure does not include Broadcom’s inheritance of $8bn of VMware’s net debt. The infrastructure firm has also secured $32bn debt financing from a consortium of banks as part of this deal. Of the new, merged firm, current Broadcom shareholders will attain 88%. VMware shareholders will own the remaining 12% and can choose either $142.50 cash or 0.2520 shares of Broadcom common stock for each VMware share they hold. The largest shareholder of VMware shares with 40.2% is Michael Dell, who has already backed and supported the deal in public and via formal agreements signed. This is no surprise with the Financial Times reporting he could earn nearly $24bn if the deal is successfully completed. Finally, given this is a large merger deal, there will undoubtedly be advisors on both sides of the acquisition. On the buy-side, Barclays, Bank of America, Citigroup, Wells Fargo, Morgan Stanley, and Credit Suisse are representing Broadcom. Meanwhile, the sell side advisors consist of Goldman Sachs and JP Morgan, with Dunn & Crutcher acting as legal counsel.
Broadcom and VMware operate in the tech industry, and this deal could be the third largest M&A deal in tech history if successfully completed. It will follow Microsoft’s acquisition of Activision Blizzard for almost $69bn (2022) and Dell purchasing EMC in 2016 for $67bn (a deal where VMware was also involved). Elon Musk’s recent acquisition of social media firm Twitter for $44bn will be replaced as the third largest deal later this year by this merger (8).
Deal values and volumes in the TMT sector from 2018 - 2022 (in $billion)
Sources: Refinitiv, Dealogic and PwC analysis (9)
The TMT sector was the most active sector for M&A deals in 2021 – with the total value of deals reaching a whopping $1.3T (10). However, in 2022, there was a decrease in activity, with 11,048 M&A deals and a total value of $841bn (11).
In both years, North America was the leading region for these deals – with for instance 2022 seeing the region accounting for 40% of global M&A deals. Within the TMT sector – consisting of technology, media & entertainment, and the telecom industries – technology saw the highest deal value and volume. In 2021, the technology subsector had 13,660 deals valued at a total of $972bn, representing 72% of all TMT deals in terms of value.
Broadcom’s involvement in the semiconductor chip market has been significant, particularly in light of the current chip shortage that has resulted from the pandemic and rising demand for innovative technologies. The global semiconductor market generated $601.69bn revenue in 2022. Within this market, Broadcom has seen market share growth, from 3.2% in 2021 to 4% market share in the following year (12), with revenues reaching $23.81bn, an impressive 26.7% increase from the previous financial year. In comparison, VMware is the dominant player in virtualization technologies, with a market share of 12.03%. It is also a leader in the HCI software market with 40.76% market share and a revenue of over $1bn – which has seen an upward trend since 2021 (13). These numbers attest to the rationale behind Broadcom’s strategic move to acquire VMware, allowing the company to expand into different sub-sectors within the TMT industry.
The proposed merger is facing regulatory challenges from Europe, as regulators are concerned about the impact of larger firms acquiring innovative rivals. In this case, Broadcom has received an antitrust warning surrounding the consequences in terms of reduction of competition that will arise due to the M&A deal being completed.
The European Commission intervened in December 2022 and launched an investigation into the deal and its effects on competition within the hardware market. It is believed the deal would allow for Broadcom to confine its competition for certain hardware pieces as a result of its acquisition of VMware (14). Finally, the UK is also involved as a challenge to the deal, with its Competition and Markets Authority (CMA) also investigating the deal whether it would affect UK markets and their respective competition (15). Late March could see a more detailed investigation initiated. This indicates the potential hurdles for both Broadcom and VMware with this deal – something that is generally expected with an M&A deal of this magnitude.
When we consider Broadcom’s position, it comes as no surprise that they are interested in taking over the cloud computing giants VMware. Broadcom is renowned for their semiconductor production which is used in several household products such as smartphones and laptops. However, due to the recent global microchip shortage and supply chain woes, which has been fueled by lead manufacturer China’s stringent COVID rules, their main source of income has been affected by delays. The acquisition of VMware acts as a means of diversifying Broadcom’s revenue streams whilst giving them a platform to succeed in the increasingly profitable software market. This sector is particularly attractive due to the business model attached with it; software companies usually use subscriptions to charge for the use of the software, which generates a steady flow of income over time for a fixed period.
Revenue synergies from this deal are projected to be considerable, mainly due to the strong position VMware holds within its respective market, holding top spot in 2021 with a 72% share. Broadcom acquired the biggest company in the datecenter market, which guarantees a high, reliable level of revenue and a wide breadth of customer base. At the same time, VMware will have access to the extensive hardware capabilities that Broadcom boast, which will generate surplus revenue as the software will be able to be benefit from the long-term stability that Broadcom offers. This has made Broadcom confident in the acquisition, which explains their goal of increasing the annual profits of VMware from $3.7billion as a standalone company to $8.5billion as part of Broadcom.
There have also been discussions about the potential synergy between Broadcom and VMware paving the way for the company to take a venture into data centers, building ARM, RISC or x86-based machines that operate effectively with the VMware layer, which will provide the company with an additional stream of income if this proves to be successful. However, these revenue synergies may not be realised, as some current VMware customers fear that the impact of this acquisition will lead to higher product costs which they can no longer afford. This fear has grown mainly as a consequence of the actions of Broadcom after they acquired Symantec and CA Technologies, as customers complained about cost increases when renewing their software subscriptions. If customers face the same price hikes with VMware after this deal, revenue synergies may be at risk due to customers leaving for cheaper alternatives.
Cost synergy is also seen to be a major benefit in this deal, as the acquisition provides Broadcom with the opportunity to integrate the software packages from previously acquired brands. Combining VMware with Symantec, a cyber security company that was acquired by Broadcom in 2019, and Arcot, a fraud prevention software acquired as part of the CA Technologies acquisition in 2018, will result in enhanced processing time and performance for the company. This enhanced performance will allow the company to cut back on operating costs, consequently aiding their profit margin.
Furthermore, they will likely look to reduce headcount in an effort to cut back on costs. However, this synergy could be jeopardised due to the concerns that customers have over Broadcom potentially stifling VMware’s innovation. Cutting back on essential research and development (R&D) means that customers will miss out on updates on popular VMware initiatives, such as its container management software, Tanzu. Broadcom can’t afford to make the same mistakes as it did with its previous tech acquisitions and will need to invest in these projects to retain VMware’s loyal customers, and this may have an adverse effect on any cost saving they try and achieve.
Deal Valuation and Financial Analysis
Broadcom Financial Analysis
Key Financials (in USD) (as of 17/03/2023)
VMware Financial Analysis
Key Financials (in USD) (as of 17/03/2023)
Comparable Company Analysis
Implied Valuation (based on median EV/Revenue, EV/EBITDA, P/E)
VMware maintains a comparable enterprise value, yet significantly higher LTM revenues, relative to many of its competitors in its peer group. VMWare trades at a significantly discounted EV/Revenue multiple (3.77x) and EV/EBITDA multiple (14.74x) to the peer group average, (8.34x and 29.19x respectively), suggesting that it is undervalued in the market relative to its peer group, and therefore may reflect a good acquisition for Broadcom. Broadcom’s acquisition at $142.50 per share reflects a significant discount relative to the implied share price of VMware, reflecting the potential for significant returns from the investment.
HP’s acquisition of Plantronics
HP’s $3.3 billion acquisition of Plantronics was financed from balance sheet cash and newly issued debt, representing a significant deal premium of 52.67%. Embracing the hybrid work model, Poly has generated significant revenue synergies in HP’s peripherals and workforce solutions businesses by combining its expertise in video conferencing software and cameras with HP’s strength in compute, device management and security, creating cross-selling opportunities while also complementing HP’s go-to-market strategy.
American Tower Investments’ acquisition of CoreSite Reality Corporation
Completed in 2021 with a transaction value of $10.1 billion and at a deal premium of 2.05%, the strategic all-cash acquisition has enabled AMT to expand its portfolio with differentiated interconnect facilities and cloud on-ramps. With strong demand for hybrid-cloud infrastructure and the convergence of wireline and wireless networks, and CoreSite has been able to capitalise on this by expanding its presence in markets such as Orlando, the “future-ready city”, and Atlanta, a technology hub with the 3rd highest concentration of Fortune 500 companies.
Cisco Systems’ acquisition of Acacia Communications
In 2021, Cisco Systems acquired Acacia Communications for over $4.5 billion in an all-cash deal, with an exceptionally high premium of 139.28%, this all-cash transaction has enabled it to develop important product lines in the webscale provider category, leveraging Acacia’s expertise in optics to enhance its product offerings. As a result, Cisco experienced a significant increase of $764 million (17%) in Internet for the Future revenues, with the benefits of the acquisition becoming apparent from the third quarter of fiscal year 2021.
Discounted Cash Flow Analysis
The terminal value of EV using the perpetuity growth approach points at a 44.9% premium to the current share price while the EBITDA exit multiple approach indicates a 35.4% premium. This showcases that the VMware stock is currently undervalued and acquiring this would imply a lesser control premium than it would have been, had the market valued this stock correctly. It has a beta of 0.83, implying a lower volatility of the stock price. Going forward, the company is expected to showcase a slow recovery in its EPS, with the consensus estimate for the fiscal year ending 2024, going up from 4.72 to 4.82.
However, there are certain risks attached to this acquisition as well. A debt to equity ratio of 7.35 implies that the company is highly leveraged and needs to raise a lot of debt to function. The return on equity (ROE) has greatly fallen in the recent past, even as earnings growth has been on the lower end of the industry averages. There are certain ESG risks involved too as the Sustainyltics score is 15, a very poor one, while the controversy level rating is higher than its peer average.
The deal is currently being investigated by the EU and Competition and Markets Authority in UK due to the risk of lessening competition substantially in the British market. In November 2022, UK’s merger watchdog invited comments from interest parties. Although an in-depth EU review found that product overlap is not a concern, the focus remains on regulatory review. However, Bloomberg Intelligence remains optimistic that ‘VMware could provide pricing guarantees to allay those concerns’, despite VMware’s 79% market share in 2021 and the sticky nature of its virtual-server products. This could provide pricing leverage over customers, given VMware’s dominant market position.
Apart from the risk of lessened competition, the proposed merger between Broadcom and VMware faces another challenge - the turnover of workers. Some departments at VMware, such as marketing, cyber strategy, and engineering, have already experienced a high rate of employee turnover. The acquisition by Broadcom could exacerbate the situation, as it raises concerns about potential layoffs. Additionally, workers are hesitant to return to the office as Broadcom CEO Hock Tan has hinted that VMware's remote work policies may come to an end, reducing opportunities to work remotely (16). As a result, several of VMware's top executives have already left the company, and an impending employee exodus poses significant risks to this deal. The situation is further complicated by the fact that employers from competing tech vendors are scouting VMware executives and employees. These uncertainties can cause anxiety and pessimism among VMware customers, affecting their future business decisions. Despite the potential opportunities that the merger may bring, the high rate of employee turnover poses a significant risk to the deal's success.
In its current state, while the company provides a lucrative opportunity for acquisition, it needs certain fundamental changes such as a debt restructuring and changing the capital structure alongside an ESG makeover. A way to go about improving the company’s financial heath would be to institute a share buyback to reduce the number of outstanding shares (NOSH) and consequently increase the return on equity (ROE). While the acquisition could allow the combined company to develop cutting-edge and cost-effective software solution, some revenue synergies may not be realized, potentially causing customers to seek out cheaper alternatives and leaving the combined company vulnerable to competition. Furthermore, the acquisition would result in increased market share, which has raised significant concerns from the EU officials and the CMA over the potential for reduced competition. It remains crucial to address underlying issues and consider potential risks before moving forward with the acquisition.