Broadcom Inc. stock suffered its worst one-day performance ever Thursday, as investors and analysts appeared confused about a self-proclaimed leading infrastructure-technology company agreeing to pay a premium for a legacy mainframe software company.
That confusion took the form of Broadcom AVGO, -13.74% stock falling 13.8% to close at $209.94, after hitting an intraday low of $197.46. Previously, the stock’s worst day was on Oct. 10, 2014, when shares finished down 11.5%. More than 43 million shares changed hands by the close, for the stock’s second-most heavily traded day ever, compared with the stock’s 52-week average daily volume of 3.3 million.
Late Wednesday, Broadcom said it was offering $18.9 billion for CA Inc. CA, +18.65% confirming earlier reports. The offer is Broadcom’s first major acquisition offer since the chip maker’s blocked acquisition of Qualcomm Inc. QCOM, +1.78% earlier in the year. Ironically, $14.47 billion was shaved from Broadcom’s market cap in Thursday trading, compared with CA’s market cap of $15.63 billion before the announcement.
Following the announcement, at least seven analysts cut their price targets on Broadcom, with three of those same analysts downgrading the stock to a hold rating, according to FactSet data. In contrast, two analysts raised their price targets, and one upgraded the stock to buy. All told, of the 38 analysts who cover Broadcom, 33 have overweight or buy ratings and five have hold ratings on the stock, with an average price target of $305.57.
Instinet analyst Romit Shah, in a note entitled “Do We Still Trust Hock?” appeared very critical of Broadcom, suggesting the deal called into question the credibility of management, while recognizing the “impeccable track record” of Chief Executive Hock Tan.
“CA is a legacy software company that specializes in mainframes — shared synergies are not obvious,” Shah said. “More important is that this deal runs completely against the investment narrative that management has been articulating since their attempt to buy Qualcomm.”
Shah has a neutral rating on Broadcom, and lowered his price target to $225 from $250.
In a note entitled “What The Hock?” Evercore ISI analyst C.J. Muse downgraded Broadcom to “in line” and lowered his price target to $275. Muse said Broadcom’s bid for the mainframe software company “seems more financial engineering/PE driven than due to any strategic rationale.”
“With software mainframe revenues in decline and no clear synergies to Broadcom’s current revenue streams, we struggle to understand Broadcom’s incentive here,” Muse said.
MKM analyst Ruben Roy, who has a buy rating and a $300 price target, was similarly nonplused by the deal.
“While Broadcom’s execution history on M&A could be viewed as a strong indicator of management’s ability to integrate acquisitions and meet longer-term financial targets, we are struggling to understand the rationale behind adding a low-growth software asset to the company’s strong portfolio of semiconductor technologies,” Roy said.
In a note, Morningstar analyst Abhinav Davuluri, who has a $300 fair value on the stock, called the bid 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.”
However, Davuluri said the deal faces challenges since “the firm faces secular growth headwinds in the mainframe market, due to the legacy nature of the platform,” and that the deal will be financed mostly through newly acquired debt. Also, it calls into question Broadcom’s intentions, announced in April, to buy back $12 billion in stock, he said.
Jefferies analyst Mark Lipacis, however, said he received assurances from Broadcom Chief Financial Officer Thomas Krause that the company remains committed to returning 50% of free-cash flow to shareholders in the form of a dividend, but Krause would only confirm that the $12 billion buyback authorization was still in place when asked about buybacks. Lipacis has a buy rating and a price target of $278 on the stock.
Bernstein analyst Stacy Rasgon, who has an outperform rating on Broadcom, said in his note entitled “Even prisoners get a phone call…” that Krause assured him CA was an “entry point to a broader move to get much bigger in the infrastructure software space, duplicating their so-far successful model.” However, this did little to assure investors Wednesday evening, Rasgon said:
Rather, our evening was mostly filled with confused and angry calls and emails as the company effectively just walked anyone who bought the stock over the last few months (on the back of small M&A/buyback commentary) right off the cliff. To that end, we are absolutely speechless that the company chose not to host a broad investor conference call; we find this decision indefensible.
On the other hand, shares of CA rallied 19% to $44.15, after hitting an intraday high of $44.20, for the stock’s best one-day percentage gain in more than 10 years, when shares gained nearly 20% on Feb. 1, 2008, according to FactSet. Thursday’s gain adds about $2.91 billion to CA’s market cap.
Three analysts raised their price targets on CA following the announcement, for an average price target of $38.60. Of the 15 analysts who cover CA, two have buy ratings, 12 have hold ratings and one has a sell rating, according to FactSet.
Shares of Broadcom are down 18% for the year, while CA shares are up nearly 33%. In comparison, the S&P 500 index SPX, +0.87% is up 4.7%, the tech-heavy Nasdaq Composite Index COMP, +1.39% is up more than 13%, and the PHLX Semiconductor Index SOX, +0.71% is up 7.4%.
