Revisiting a Strong Growth Play
Broadcom designs, develops, manufactures and supplies a broad range of semiconductor and infrastructure software products. Its product portfolio serves the data center, networking, software, broadband, wireless, and storage and industrial markets. The company recently announced the purchase of Symantec’s enterprise security business for $10.7 Billion. The acquisition is part of the company’s strategy for growth, which has helped it to widen its reach through an expanded product portfolio. Broadcom also acquired CA Technologies in November 2018 for $18.9 billion. The acquisition of networking company Brocade in 2017 and mainframe solution provider CA technologies in 2018 together have created a substantial software business within Broadcom. The software segment alone is expected to contribute 22% to revenues in 2019 and the acquisition of Symantec – the enterprise security system – would enable the firm to further expand its market share with the software business. As per management, the acquisition would boost Broadcom’s software solutions revenues up to 29% of total revenues and reduce the semiconductor business contribution to 71% from 78%. When Hock Tan and Broadcom first announced the company’s foray into the software business, he was met with skeptic. Many analysts felt that the deal was far from the capabilities developed by the company. It was also an incredibly expensive purchase just months after Tan stated the company would be focusing on smaller acquisitions and returning capital to shareholders.
The acquisition of CA Technologies was a way for Broadcom to diversify its semiconductor business into infrastructure software along with buying a company generating free cash flow that Broadcom could reallocate to its key technology verticals. Prior to the acquisition, CA was generating free cash flow of about $1.1 billion and has paid 70% of FCF in dividends including share buybacks. The acquisition also reduces the cyclability that is inherent in the semiconductor industry. The CA acquisition also exposes Broadcom to entirely new industries with their software products that they did not have access to when only selling hardware. Broadcom has made the decision to offer their Infrastructure Software as an all encompassing subscription package. They plan to offer software solutions from both CA and Symantec for one price which should generate stable recurring revenue.
Broadcom has seen incredible growth over the past five years, with revenues rising from $4.3 Billion in 2014 to $20.8 Billion in 2019. The firms EPS in this time also increased by nearly 400% from $4.90 to $20.82. All the while, Broadcom’s management has been incredibly friendly to shareholders and has laid out a plan to continue this in the future. Free Cash Flow has grown at a CAGR of 81% which allowed the company to establish an aggressive share buyback program as well as a dividend that has increased every year since 2014. Since 2018, the firm has spent $13.1 Billion in Share Buybacks, removing over 50 million outstanding shares from the market. The firm plans to allocate at least 50% of FCF in the form of a cash dividend going forward while the remaining amount will be used to deleverage the balance sheet and prepare for any future acquisition. The firm has aggressively been using leverage to fund their purchases of CA and Symantec, with long term debt rising from $13 Billion in 2016 to $34 Billion today. Net Debt to EBITDA is currently at approximately 3.4x, which management believes is within range of long term goals. The firm could very easily begin to pay down this debt in the event of financial hardship, and I don’t believe they are currently in any risk of insolvency. The cash generated from operations can easily cover their current liabilities. However, the company barely maintains an investment grade bond rating, which means that in the event of a more broad economic downturn, they could be relegated to junk status. This may make it more difficult for the firm to refinance their current debt position or find other sources of capital to complete another acquisition. I believe that the firms debt needs to be watched closely, however I do not believe the situation is as precarious as some may believe. The company has guided for over $10 Billion dollars in Free Cash flow for the next 12 months, meaning in a worst case scenario they could reduce the debt load by 1/3.
Hock Tan has utilized a “Roll Up” strategy to build Broadcom into one of the global leaders in the semiconductor industry. I believe the company plans to use this same playbook in the enterprise software market which would provide them a higher margin business with far more predictability in revenues. Some analysts may question this approach, comparing Broadcom to the likes of Valiant, which I do not believe to be fair. Tan proved himself with his first big bet on CA Technologies, and any additions to the software portfolio will only bolster the cross selling opportunities. Going forward, I look forward to and welcome any other acquisitions they may be considering.