July 12, 2018 / 12:51 PM / 3 months ago

"What the Hock?"; Broadcom shares sink on shock software deal

July 12 (Reuters) - Broadcom Inc’s surprise bid to buy software company CA Inc knocked $11 billion off the value of the chipmaker in trading before the bell on Wall Street on Thursday, with analysts struggling to find a clear rationale behind the deal.

Broadcom, which has mushroomed in value by buying out rivals in the past decade’s surge in mobile phone production, agreed on Wednesday to buy mainframe software company CA for $18.9 billion in cash, months after President Donald Trump blocked its $117 billion mega-merger with Qualcomm Inc.

While some analysts said the shift in sectoral focus might prove another masterstroke by Broadcom Chief Executive Hock Tan, the knee-jerk reaction of investors drove Broadcom stock 10 percent lower in premarket trading. CA rose 18.5 percent to $44.10.

“What the Hock?” analysts from brokerage Evercore wrote in a note. “We think investors will likely be disappointed at this deal, which seems more financial engineering/PE driven than due to any strategic rationale.”

Broadcom’s famously ambitious chief executive has built the company from a fledgling chipmaker to a global powerhouse through a series a ambitious deals, and is widely respected by Wall Street for his business acumen.

Susquehanna analyst Christopher Rollan said the foray into the software industry may have been driven by a lack of viable options in the semiconductor industry and increased regulatory scrutiny.

CA’s main business is selling software for big, mainframe computers, in which it is second only to IBM.

But while that business generates cash flow of $10 billion a year, its revenue growth has been flat as more customers choose cloud services over old-fashioned hardware.

“While CA is a departure from Broadcom’s core semiconductor business, it is consistent with its track record of acquiring out-of-favor, market leaders with high cost structures,” Jefferies analysts said.

“Importantly, AVGO has consistently demonstrated its ability to drive costs down and margins of its acquisitions up, often measured in 1,000s of basis points,” they said.

Some analysts speculated that Broadcom’s ability to rein in costs would help it use CA as a platform to build a business in the software sector that simply offsets the risks of the highly-competitive semiconductor business.

“Management is showing its ambition to move beyond silicon to be that of an Infrastructure Technology company,” Morgan Stanley analysts said.

After the deal, the combined company would have roughly 71 percent revenue from semiconductors and 28 percent from software.

“We think many investors may not like it - at least initially - but this does open the door for a new angle to the story and further improves AVGO’s capital return potential (we model $10/sh dividend in F19) in the meantime,” UBS analyst Timothy Arcuri said. (Reporting by Sonam Rai in Bengaluru; editing by Patrick Graham)

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