Last year Broadcom pursued an acquisition of SAS Institute (private) before SAS Co-founder and CEO Jim Goodnight withdrew. Now, the WSJ reports that Broadcom (AVGO) is working to acquire private cloud and infrastructure software provider VMware (VMW). While the SAS pursuit was bold and creative, the prospective VMW acquisition is bold, risky and lacks creativity. We would encourage Broadcom to pass on VMware and instead focus on other acquisition targets.
Sure, acquiring VMW will help bolster AVGO’s recurring revenue base ($3.2 billion or 25% of VMW’s FY 2022 revenue was “Subscription and SaaS”), but at what cost? By cost we are referring not only to purchase consideration (VMW currently has a Market Value of $40.4 billion and an Enterprise Value of $49.5 billion), but the ongoing cost of maintaining VMware’s competitive positioning in the marketplace.
VMware’s core business is its private cloud business. Investors should not forget that while AWS (AMZN), Azure (MSFT) and Google Cloud (GOOG) are known for their public cloud offerings, each also has a private cloud offering. Our view is that AWS, Azure and Google Cloud are the crown jewels of Amazon, Microsoft and Alphabet respectively. Each of those companies dwarf Broadcom from a Balance Sheet perspective. Therefore, Broadcom is at a significant disadvantage vs. the three cloud platform giants in terms of the amount of capital AVGO may deploy toward keeping VMware’s cloud platform fresh. Yes, we are aware that VMware partners with AWS and Azure in hybrid cloud (public/private) deployments, but the companies also compete and make no mistake: AWS, Azure and Google Cloud want to win every Enterprise deal possible (VMware primarily plays at the high-end of the market).
Below we include some valuation and financial metrics. VMW currently trades at 11.4x EV/Operating Cash Flow. Over the past two years VMW shares peaked at $167 on October 22nd, 2021 and VMW shares were last at their current level in August 2017. A 40% premium would get VMW shares back near its recent high of $135.87 on February 9th 2022.
I would have advised Broadcom to pass on the VMW deal. I believe that VMW is a mid-single-digit percentage grower over the long-term as a standalone company. Once inside of Broadcom, I believe VMW’s revenue growth will slow immediately (Interesting side note, Broadcom’s last large acquisition was when it acquired CA for $18 billion in 2018. CA used to be known as a Software graveyard of sorts in the 1990s and early 2000s because once it acquired a company, it would reduce investment in the acquired company and that acquired company would eventually cease to grow). Slow revenue growth and looming competition from AWS, Azure and Google Cloud would be enough to persuade me to look elsewhere for acquisition candidates.
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