The $130 billion offer by Broadcom Ltd. for Qualcomm Inc. announced this week will rank as the industry’s biggest deal but that designation alone should give cause for concern. Huge deals like this are notorious for not meeting expectations and a hard look at the facts indicate Broadcom’s shareholders may in time come to rue this move.
If Broadcom gains regulatory and Qualcomm investor consents, the company would nominally become the No. 3 global semiconductor vendor by revenue. It will also have a boatload of debts and a raft of legal skirmishes involving companies like Apple and anti-trust fines and scrutiny in the European Union, China and Korea. It must appease skittish customers wary of getting locked into sole-sourcing agreements. Add to this the difficulties of integrating three different companies, and Broadcom’s outlook may not look quite as rosy as the management would like everyone to believe.
The offer for Qualcomm is itself emblematic of the bloated ego driving M&A transactions in the semiconductor market. Hock E. Tan, president and CEO of Broadcom, exemplifies some of the hubris. The proposed purchase of Qualcomm is the second “Biggest Tech Deal” Tan has championed in as many years. In 2015, Avago paid $37 billion for Broadcom Corp. in what was touted then as the largest such transaction in the history of the semiconductor market. Upon completion of the transaction, Avago changed its corporate name to Broadcom Ltd. and, under Tan, proceeded to make additional acquisitions, including the pending $6 billion offer for Brocade Communications Systems Inc.
The Brocade transaction is now under review by the Committee on Foreign Investment in the United States (CFIUS). Why? Because Broadcom, while still Avago, shifted its corporate domicile to Singapore to take advantage of generous tax benefits offered by the Asian country. The tax benefits have the downside of attracting harsh U.S. scrutiny of any other acquisitions by Broadcom. The short-sighted Singapore domicile action has now been reversed by Broadcom, which announced this decision only a few days before unveiling the offer for Qualcomm. As a U.S. domiciled company, its M&A transactions will not come under the review of CFIUS. So, Broadcom will sacrifice the Singapore tax benefits, all of which will expire anyway by 2025.
“We believe the USA presents the best place for Broadcom to create shareholder value,” Tan said, in a statement Nov. 2. “We expect the tax reform plan effectively to level the playing field for large multinational corporations headquartered in the United States and to allow us to go all in on U.S. redomiciliation. However, we intend to redomicile to the United States even if there is no corporate tax reform.”
Something is wrong with that statement. Broadcom is not just relocating to take advantage of a tax law that has not passed Congress. It wants to correct a blunder made when it registered the business in Singapore. So, if Broadcom cannot be blunt about its Singapore-to-U.S. move, can the management be trusted to lay out in specific terms the challenges it might face with the Qualcomm transaction?
It’s statement regarding the Qualcomm offer did not offer risk disclosure. It was cheery and overwhelmingly positive. The purchase should receive prompt regulatory approval and greatly expand the company’s reach into new markets, secure its place in existing ones and be immediately “accretive to Broadcom's Non-GAAP EPS in the first full year after close,” according to Broadcom. No downsides?
“This complementary transaction will position the combined company as a global communications leader with an impressive portfolio of technologies and products,” Tan said in the statement announcing the Qualcomm offer. “We would not make this offer if we were not confident that our common global customers would embrace the proposed combination. With greater scale and broader product diversification, the combined company will be positioned to deliver more advanced semiconductor solutions for our global customers and drive enhanced stockholder value.”
Thomas Krause, Broadcom’s CFO, added: “The Broadcom business continues to perform very well. Broadcom has completed five major acquisitions since 2013, and has a proven track record of rapidly deleveraging and successfully integrating companies to create value for our stockholders, employees and customers. Given the complementary nature of our products, we are confident that any regulatory requirements necessary to complete a combination with Qualcomm will be met in a timely manner. We look forward to engaging immediately in discussions with Qualcomm so that we can sign a definitive agreement and complete this transaction expeditiously.”
Neither executive mentioned the elephant in the room. The new Broadcom will start life stuffed with debts. Qualcomm itself is still in the process of securing investor and regulatory approval for its $47 billion offer for NXP Semiconductor. That deal has been mired in delays due to objections from European regulators and continuing shareholder demand for a higher premium. Although Broadcom says it would still proceed with the Qualcomm offer irrespective of the outcome of the NXP deal, it is obvious this is not going to be a straightforward transaction.
The company also made light of the debts that Broadcom will have to assume to finance the transaction. Instead, it emphasized that the “transaction will not be subject to any financing condition.” Why? Because a bunch of investment firms, including “BofA Merrill Lynch, Citi, Deutsche Bank, J.P. Morgan and Morgan Stanley have advised Broadcom in writing that they are highly confident that they will be able to arrange the necessary debt financing for the proposed transaction.”
Additionally, “Silver Lake Partners, which has served as a strategic partner to Broadcom in prior transactions, has provided Broadcom with a commitment letter for a $5 billion convertible debt financing in connection with the transaction,” the company said.
Okay. The financing won’t be a problem. But let’s do the numbers. Broadcom closed its last quarter with about $5.5 billion in cash and short-term securities. It also reported $13.5 billion of long-term debt. The biggest asset on the company’s balance sheet was goodwill valued at $24 billion. That’s a vault filled with vapor. On to the target, Qualcomm. The wireless IC vendor had $37 billion in cash and short-term investments and long-term debts of about $19 billion at the end of September. A large portion of the money in Qualcomm’s kitty has been reserved for the $47 billion NXP acquisition. It will make up the difference in debts.
It appears the combined entity would begin life mired in debt. How will this impact operations? Broadcom’s management believes it won’t, after all, they can whittle down the debts quickly with the company’s strong cash flow. Perhaps they’ll sell more shares, too.
Qualcomm’s shareholders shouldn’t worry quite as much, though. They will win from the gate. Broadcom expects to pay $70 per share for Qualcomm with $60 of this in cash. The remaining $10 per share would be payable as shares in Broadcom, giving the sellers a hefty premium on their investments and the potentials for extra gains from the combined enterprise. What Broadcom’s shareholders will get in return won’t be as easy to determine. It will take years, possibly five years or longer, before anyone can decide whether a transaction of this scale was a success or not. By then CEO Tan would be gone.
At 67, Tan is close to wrapping up what is an undeniably illustrious career. He has served in top management positions at several semiconductor vendors and was previously president/CEO at Emulex, Integrated Device Technology, PLX Technology and Integrated Circuit Systems. But these are not Tan’s biggest achievements. In a mere span of 5 years, the mechanical engineer transformed Broadcom into one of the industry’s biggest players and pushed its market value up to more than $110 billion from a mere $4 billion at its initial public offering. Under Tan, Broadcom’s revenue soared to $17 billion (projected) for fiscal 2017 ended Oct. 31, from $2.5 billion in fiscal 2013.
Avago, as Broadcom was initially known, has grown primarily through acquisitions, adding enterprises such as Broadcom Corp., Emulex, LSI and PLX Technology. It has agreed to pay $5.9 billion for Brocade Communications. The company’s biggest $37 billion purchase of Broadcom vaulted Avago to a leading position in the market. So, Tan has been a good steward at Broadcom. But he is getting ready for a flamboyant exit. Qualcomm and the new Biggest Tech Deal should make his eventual departure memorable.
But what about the Qualcomm Deal?
The sum of Broadcom and Qualcomm will not be one-plus-one equals two. Some current revenue will be lost once the companies combine operations as some OEMs flee, wary of getting locked into a sole-supplier situation. Other customers will nurture secondary sources. What OEMs dislike even more than loud suppliers is becoming a captive customer dependent upon a vendor’s design, product development and production schedule.
Moreover, the transaction avoids one of the more vexing issues facing the global electronics industry: What to do about China and it’s loudly-stated desire for a strong and viable domestic IC design and manufacturing industry. Even as Broadcom tries to win U.S. approval of this deal, it must also ask: What will China think of a Broadcom-Qualcomm hook-up? Is China applauding with Qualcomm’s shareholders or is it instead thinking, “they want to hustle us into a tighter corner?”
If the latter you can bet the acquisition will undergo even tighter Chinese scrutiny, which may delay or even scuttle the transaction. Chinese approval of this transaction may also be contingent upon the parties agreeing to severe, constraining conditions. Broadcom may have to consent to nurturing local rivals and possibly the transfer of certain intellectual property to local Chinese entities, a condition the U.S. will view with concerns.
This doesn’t mean Broadcom will not eventually succeed in gobbling up Qualcomm. It may. But it raises the possibility that the combination will underdeliver on its promises just like the promised synergies HP expected when it bought Compaq did not materialize.
Which brings up the question of why Broadcom’s board of directors is going along? The transaction gives Broadcom some leverage in the industry’s tough competitive environment. It gets the opportunity to bulk up and become an even bigger player in several critical markets. The transaction will accelerate the consolidation of the Western chip market, providing a bulwark against the anticipated Chinese assault on their dominance.
For this reason alone, Western governments – if they are smart – should quickly approve it. Would this be enough to keep China at bay, though? No. Many of the markets a combined Broadcom-Qualcomm wants to dominate are growing faster in China. It is today, the world’s No. 1 market for autos and smartphones and can only get bigger.
By the time Broadcom’s shareholders realize they’ve pushed out solving the Chinese problem Tan would be gone. Somebody needs to think about that future because it comes. Fast.