Avago Technologies Ltd (NASDAQ:AVGO) Is Making All The Right Moves
Avago Technologies Ltd (NASDAQ:AVGO) has always sought to prove that it has a clear roadmap to the future. When people have sometimes seemed to doubt its confidence, Avago makes a move to prove a point – that it can buy growth and gain a spot in the top ranks of chip companies.
In its boldest move ever, Avago is acquiring Broadcom Corporation (NASDAQ:BRCM) for $37 billion. But there is a question: what does the acquisition mean for Avago and the semiconductor industry that has been undergoing major shifts in recent times?
A look at the deal with Broadcom should show whether Avago is simply buying assets because that is its style of growth or if the company has more to secure from combining with Broadcom.
The simple answer is that by reaching out for Broadcom, Avago Technologies Ltd (NASDAQ:AVGO) is making the right moves that can be expected of any well-managed company. However, the whole story requires detailed analysis to clearly reveal the underlying benefits of the deal.
Broadcom’s purchase price
Avago Technologies Ltd (NASDAQ:AVGO) agreed to pay $37 billion for Broadcom in a transaction that involves both cash and stock. The cash component of the deal is $17 billion and the balance of $20 billion will be settled through stock.
If all goes according to plan and the transaction is closed in the first quarter of 2016, shareholders of Broadcom will own 32% of the combined company.
Broadcom makes chips used in consumer devices, such as smartphones, and it counts Apple Inc. (NASDAQ:AAPL) among its chip customers. The company enjoys a respectable operating margin lead in the data center market with its operating margins being 700bps above the market average. Broadcom also has the opportunity to drive more margin improvement as it ramps up its data center offerings.
Regulatory issues: There is a high chance that regulators will approve the combination of Avago Technologies Ltd (NASDAQ:AVGO) and Broadcom because there is no serious overlap in their product portfolios.
There are major shifts taking place in the global semiconductor market currently. Chip buyers are consolidating their list of suppliers so that they can buy more from a small number of suppliers. At the same time, chipmakers are consolidating their operations so that they can expand their capacity and product portfolio without taking in more expenses to expand sales organizations and backend operations.
In taking over Broadcom, Avago Technologies Ltd (NASDAQ:AVGO) is trying to both fit in the new buyer approach to components sourcing and also expand its product mix quickly. In the new dispensation, Avago will be well-placed to keep up with the pace and strategy of large customers like Amazon.com, Inc. (NASDAQ:AMZN) and Apple.
Avago’s CEO, Hock Tan, told analysts that an expanded portfolio of products, thanks to the acquisition of Broadcom, will enable the company to become more relevant. That relevance can be seen in the company offering a variety of chip technologies under one roof so that buyers can get most of what they want from a single supplier. Additionally, relevance can be seen in the company being able to expand quickly to satisfy demand.
Chinese 4G LTE market
Avago Technologies Ltd (NASDAQ:AVGO) enjoys significant exposure to China’s robust 4G LTE market. The acquisition of Broadcom will significantly boost the company’s wireless products portfolio, enabling it to make more sales in China’s thriving wireless industry.
By bringing Broadcom under its umbrella, Avago is set to become the third-largest semiconductor company in the world, only behind Intel Corporation (NASDAQ:INTC) and Qualcomm, Inc. (NASDAQ:QCOM). An elevated profile in the semiconductor industry will enable the combined company to enjoy greater influence over customers and manufacturers, thereby boosting margins, cash flow and EPS.
The combined entity of Avago and Broadcom is expected to have annual revenue of $15.1 billion. Both Avago and Broadcom have a strong product mix, capable of driving continued growth for the combined company.
In recent times, semiconductor manufacturers have preferred to buy growth so that they can expand capacity quickly while keeping operating costs low. That is true for the deal between Avago Technologies Ltd (NASDAQ:AVGO) and Broadcom. Combining sales forces is a key area to drive cost advantages, and Avago has the opportunity to do just that.
The company is hoping to generate $750 million in cost-saving within the first 18 months after closing the acquisition of Broadcom, with the possibility to do more going forward.
Avago Technologies Ltd (NASDAQ:AVGO)’s elevated profile will not only benefit the company, because of the large scale and greater influence over customers and partners, but also make it more attractive to financiers. The low interest rate environment also presents the company with a low-cost debt financing avenue, enabling it to raise funds for various projects to continue boosting its position in the semiconductor industry.
Avago’s base in Singapore also puts it at the center of a low tax rate.
Avago Technologies Ltd (NASDAQ:AVGO) finished its fiscal 2nd quarter 2015 with cash and equivalents of $2.57 billion.
Potential risk areas for Avago
Capacity expansion has been an issue for Avago Technologies Ltd (NASDAQ:AVGO) and has hindered strong revenue gains. However, excessive capacity may also impact revenue and profits as the company is forced to cut prices to encourage uptake. That simply calls for cautious capacity expansion, and given that Avago has always preferred to grow through deals, the management can be trusted to know how to avoid capacity backlash.
Avago’s other recent major acquisitions include a $606 million deal early this year to purchase Emulex and $6.6 billion it paid in 2013 to bring networking and storage chipmaker LSI Corporation under its control. The company has been successful in integrating its acquisitions.
Avago Technologies Ltd (NASDAQ:AVGO) reported its second quarter 2015 revenue of $1.61 billion and EPS of $2.13. The numbers improved from the same quarter in the previous year where revenue was $701 million and EPS came in at $0.85. Analysts on the average expected revenue of $1.63 billion and EPS of $2 in the latest quarter.
The company guided its 3rd quarter 2015 revenue at about $1.7 to $1.75 billion. Consensus estimates call for revenue of $1.67 billion.
Avago Technologies Ltd (NASDAQ:AVGO) has grown through deal-making, and the strategy has worked well for it, which gives confidence about this one with Broadcom being a success too.
Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.
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