Stock Analyst Update

Broadcom's Bid Is Puzzling, but Financially Reasonable

Abhinav Davuluri
Brian Colello, CPA

On July 11,  Broadcom (AVGO) announced it will acquire  CA Technologies (CA) for $44.50 per share in cash, or $18.9 billion. Four months after the firm's failed attempt to acquire Qualcomm, Broadcom is back in the M&A mix, though this deal doesn't have any clear synergies, in our view. CA is a key vendor of IT management software and solutions for mainframe infrastructure and enterprises. The deal has all the signs of a typical Broadcom deal, including: a modest premium (20% over closing price on July 11); high profitability (85.8% gross margins last year), while adding to Broadcom's treasure trove of market-leading franchises. Despite a lack of meaningful growth, the potential for cost-cuts and stable performance of CA's mainframe business should allow for solid non-GAAP EPS accretion. The deal represents a 27% premium to our fair value estimate of $35 for CA, which we think is a reasonable premium for Broadcom shareholders.

Following our preliminary take on the valuation of the combined firm, we are maintaining our $300 fair value estimate and narrow moat rating for Broadcom, as we believe the accretion stemming from the deal is offset by the premium paid. We will maintain our $35 fair value estimates for narrow moat CA. While the 27% premium is rather modest for a tech merger, the stock price for low-growth CA hasn't reached the $40 range or higher in the past 15 years, so shareholders might be wise to lock in profits. We do not anticipate any regulatory hurdles to approval, given the lack of synergies between the two firms, though it would not surprise us if the current geopolitical climate and trade tensions between the U.S. and China delayed the closing. Shares of Broadcom fell 6% during after-hours trading, as the market appears to disapprove of the deal, but we remain positive on the firm's powerhouse networking, RF filter, and connectivity portfolios.

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Abhinav Davuluri does not own shares in any of the securities mentioned above.
Brian Colello, CPA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.