The lack of meaningful synergies coupled with more qualified suitors in the market makes Broadcom (NASDAQ:AVGO) an ill fit for VMware (NYSE:VMW). While Broadcom’s offer is likely to open a whole host of opportunities from VMware, Broadcom may lose out not only on VMware but also on its reputation.
Deal Offer Summary
VMware and Broadcom have entered into an agreement to merge, with the combined entity getting rebranded as VMware. The cash and stock deal values VMware at $61 billion, with VMware shareholders getting the choice to receive $142.4 or 0.252 of the Broadcom common stock. On a pro forma basis, erstwhile Broadcom shareholders will own 88% of the merged entity, and the remaining 12% will be with VMware shareholders.
Rationale For The Merger
Broadcom’s logic to acquire VMware is as follows:
Broadcom has been moving towards a more software-oriented business model, and VMware appears to be the latest in Broadcom’s aspirational journey towards becoming an enterprise application lifecycle provider.
Broadcom’s confidence in executing the $61 billion deal stems from its experience.
We, however, are unable to find merit in this deal.
Our Analysis Of The Deal
To begin with, neither company has talked about any synergies from the deal. A read of the press release on VMware’s website shows the mention of synergies only thrice, and each of those instances is in the disclaimers. Even Broadcom’s presentation on the VMware acquisition has three mentions of ‘synergies’, again in the legal disclaimer.
So, we dug through the company filings.
Much of Broadcom’s revenues come from its hardware business, and the software business has a minimal SaaS component (if any).
On the other hand, SaaS is the fastest growing component of VMware’s revenues.
So, on the surface, the new entity could have a $20 billion software and services business. But to understand the potential synergies, we compare the business lines.
We note that VMware was spun out of a hardware-focused Dell-EMC unit, highlighting the need to run VMware as a standalone business.
Google’s (GOOG) (GOOGL) acquisition of Cornerstone to help migrate mainframe workloads onto the Google cloud should not be considered a good parallel, given that Google is a hyperscaler and VMW is an integrator.
Thus, unless Broadcom has a major (>$62 billion, VMware’s net worth was a negative $876 million at the end of fiscal 2022 due to all the money having gotten distributed out as dividends) 5G play up its sleeve, we can’t see the logic for this transaction.
However, there may be other, more qualified suitors for VMware.
Intel Could Be The Most Suitable Alternative To Broadcom
The fact that Michael Dell and Silver Lake had agreed to vote in favour of a transaction if the VMware Board recommends the transaction shows that Dell-EMC has moved on, and VMware is now free to fly.
While Pat Gelsinger might have moved from VMware to Intel (INTC), the latest re-organization of Intel’s business units look very much aligned with VMware’s.
We see tremendous synergies for VMware and Intel:
- VMware’s virtualization business complements Intel’s CCG business unit and could give CCG a significant lift.
- VMware has been a leader in data centres. With Intel’s DCAI’s 22% y/y revenue growth expected to slow down, selling into VMware’s customer base could be a boon.
- VMware’s layer 2-7 software solutions could benefit from Intel’s networking business growth, with NEX expected to grow faster than the market.
- AXG and Mobileye could again benefit from VMware’s cloud management and infrastructure businesses, leveraging VMware’s relationships with the major hyperscalers.
With a net cash position of $6 billion, Intel will neither find it hard to raise capital nor find it difficult to conjure up the political will (with Pat as the CEO) to execute this transaction.
Of course, the post-merger integration risks and potential need to divest non-core business areas could make this a difficult decision.
Amazon & Google Could Both Throw Their Hats In The Ring
Our recent piece on Amazon (AMZN) talks about how Andy Jassy’s baby is now ready to come out of the shadows of the retail business, and building upon the VMware Cloud on AWS might be the move that stamps AWS becoming an independent entity. Also, Amazon would not want the effort put into its collaboration with VMware to get lost when VMWare could virtually guarantee continued strong growth for the AWS business.
In fiscal 2020, we also announced partnerships with Microsoft (Azure VMware Solution by CloudSimple), Google (Google Cloud VMware Solution by CloudSimple) and Oracle (Oracle Cloud VMware Solution) under the framework of our VCPP that enable customers to run native VMware-based workloads on each of Azure, Google Cloud and Oracle Cloud. Our partnerships with AWS and other public cloud providers may be seen as competitive with each other and with other VCPP partners, while some partners may elect to include solutions such as VMware Cloud on AWS as part of their managed services provider offerings.
Source: VMware 10K – 2022
Google could be in the fray with GCP and has become a formidable force under Thomas Kurian, who had restructured the GCP unit last year. Adding a leading hybrid cloud provider will help further Kurian’s efforts toward modularising GCP.
While the money to do this is unlikely to be a concern for either of Amazon or Google, we think Amazon has an advantage given VMware’s long-standing relationship and growth with AWS.
Note: For readers looking for greater context in the discussion on the cloud, the following article may be worth reading: Masters Of Cloud, Part 4: The Post-COVID World.
IBM Could Be The Dark Horse
One of the arguments against VMware’s acquisition by any hyperscalers (including Microsoft (MSFT), Oracle (ORCL) and others) is the potential loss of platform neutrality and one of VMware’s biggest USPs. After Red Hat got acquired by IBM, VMware was possibly the only pure-play hybrid cloud player remaining. With IBM cutting flab to focus on software, we think VMware’s addition could create a hybrid cloud behemoth.
What goes against this deal is IBM’s ability to raise the money needed and historical acrimony between Red Hat and VMware.
While many other large tech firms could make sense of VMware, we think Intel and Amazon are the front-runners.
What Could VMware Fetch
We look at the market capitalization (as of 18th May, or before the deal rumours began to surface) of Broadcom and VMware to understand the synergies attributed to this deal.
Given there appear to be limited operational synergies, we assume that Broadcom would have required to share around 50% of the potential synergies with VMware to make it attractive for VMware’s shareholders. Accordingly, we think the whole value creation in this deal is around 20% of the combined market capitalization of the two companies.
A Possible Offer From Intel
Suppose Broadcom’s negligible operating synergies can lead to a 20% kind of value creation for the combined entity. In that case, we think Intel’s operational synergies could create 40-50% value of the combined market cap.
Assuming a 50-50 split of synergies between the two companies, Intel could easily offer 25-40% above Broadcom’s offer. Intel may offer higher given that the merger is unlikely to see any cultural challenges given Pat has or was at the helm of both companies.
What Amazon Could Offer
We had earlier estimated AWS to be worth around $1.5 trillion.
Building on that, we think AWS could see significant synergies from getting an entry into VMware’s data centres. We estimate synergies of 30-50% could be possible given AWS’ expertise in scaling businesses. In the same breath, we also note that Amazon is unlikely to be willing to offer any more than 10% of those synergies to VMware, given VMware’s existing dependence on AWS.
Our analysis suggests another potential 20-120% upside on top of Broadcom’s offer is not unlikely should AWS decide to go after VMware.
Google’s offer could be on similar lines but could be much better since they would need to cough up much more of the synergies to VMware, given the lack of VMware’s dependence similar to that on AWS. What might deter Google is its recent acquisition of Mandiant, which might take a while to integrate into the cloud division fully. We, however, would be keenly watching Kurian’s reaction to a VMware deal.
After the last round of $9 billion of dividend payout, Dell seems to be releasing VMware from its clutches. The first suitor has put a price tag of $61 billion for an asset that is essentially the gateway to data centres. Conceptually, we think it makes sense for VMware to get acquired, but the lack of synergies with Broadcom might make Broadcom a stalking horse. We remain positive on VMware and negative on Broadcom, given the potential for reputational damage, Broadcom could face in light of another failed acquisition attempt.
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