Broadcom’s CA Gamble: Hit or Miss?

There are certain entities in the technology world who can be best described as predators or more politely ‘habitual acquirers’. Oracle has long been recognized as one subscribing to this inorganic growth pattern; to a lesser extent, Cisco has been another. The chip company Broadcom is another prominent name in the list.

After its abortive attempt to acquire Qualcomm earlier in the year (Trump administration stalled its hostile bid), this week Broadcom announced its decision to acquire CA technologies for $18.9bn in cash. While another acquisition by Broadcom is not a shock, few expected the target to be a 42-year-old enterprise software firm. It is indeed reasonable to wonder if Broadcom is putting itself too far outside its traditional domain strength this time around.

Is future Positive?

CA’s product lines include several enterprise software offerings that handle everything from managing software projects to monitoring the performance of apps and IT hardware to testing app security to protecting against unauthorized data access. In fiscal 2018 (ended in March), the company posted revenue of $4.24 billion (up 5%).

Broadcom might now look to streamline CA's product line by selling assets deemed non-strategic. And to raise prices on CA products that command high market shares, have limited competition and claim a high level of customer stickiness. Some of CA's mainframe offerings for developers and IT admins appear to fit this description.

The company still gets over half its revenue from mainframes, and Broadcom apparently sees this as a positive. Also seen as a positive is the fact that CA's software and services bookings have an average duration of more than three years, yielding a large base of recurring revenue streams.

The CA acquisition could very well pay off for Broadcom if CA continues to see a modest amount of positive revenue growth and Broadcom's management executes well on the deal. But there is a very big ‘IF’here considering that CA's software portfolio is a very mixed bag.

Some of the markets in which CA has a strong presence, such as offerings for DevOps software teams, Agile code development, identity management and privileged account security, are seeing healthy growth. On the other hand, mainframe software is a field that (while stable) is likely to see little to no long-term growth.

And various other CA businesses face stiff competition -- often from cloud software upstarts such as ServiceNow and New Relic or they are being impacted by the adoption of cloud infrastructure services from the likes of AWS and Microsoft Azure.

On the positive side, CA does have partnerships with some of Broadcom's major enterprise OEM clients, such as IBM, HPE and Cisco. And -- in what's perhaps a sign that it is open to making additional software deals down the line -- Broadcom claims that pairing its products with CA's will create "one of the world's leading infrastructure technology companies."

Thumbs Down from Analysts

Majority of the analysts though do not share this optimism. They feel there are few or no product synergies between many of CA's offerings and Broadcom's current product line. And in terms of sales, R&D, distribution and much else, the enterprise software industry is a very different animal than the chip industry or even some of Broadcom's enterprise-focused hardware markets such as Ethernet adapters and storage switches.

"This deal hurts management's credibility," says Nomura Instinet analyst Romit Shah. The deal is out of character for Broadcom, which historically has bought other chipmakers. CA, on the other hand, makes software for managing information technology systems. Broadcom's move to buy CA Technologies comes "out of left field," he said. "CA is a legacy software company that specializes in mainframes — shared synergies are not obvious." The deal also raises questions about long-term growth prospects for Broadcom's core wireless and wired communications chip businesses, Shah added.

1. Riley FBR analyst Craig Ellis compared the deal to chipmaker Intel’s purchase of security software firm McAfee. Intel had trouble rationalizing that purchase and ultimately sold McAfee to a private equity firm.

The CA purchase lacks strategic rationale and seems more like "financial engineering" and a private equity play says Evercore ISI analyst C.J. Muse."Further, investors will likely be concerned on a 'loss of focus' in terms of broadening exposure outside of semiconductors," he said in a report. "We note that CA Technologies had been in the process of selling itself and had failed to attract a private equity buyer," Muse said. "With software mainframe revenues in decline and no clear synergies to Broadcom's current revenue streams, we struggle to understand Broadcom's incentive here."

UBS analyst Timothy Arcuri though is sympathetic and willing to give Broadcom CEO Hock Tan the benefit of the doubt. He noted that Tan has a proven track record of wringing value out of acquisitions. Broadcom could become a consolidator in the infrastructure software space, Arcuri feels.

Consolidation in the chip sector may be nearing an end, but consolidation in the servers, storage and networking markets is in full swing. That is particularly true as software takes over more of the functions carried out by the discrete pieces of hardware that take up space in the data centre. Tan still has to convince his shareholders and analysts and in the long run, the industry that he can master the software markets as well as he has chips.