Editor’s Note: Broadcom was once a leading semiconductor company before it began acquiring enterprise software companies. People in the financial world recognize Broadcom, and people in technology recognize it, but they just don’t want to accept it. We can’t blame them for this sentiment.
Broadcom exists as a derivative of a derivative. About two decades ago, HP began its miniaturization process. First spin off Agilent, which contains a hodgepodge of businesses that have nothing to do with PCs or printers. Agilent in turn split itself into several parts, one of which was HP’s once-in-house chip business, renamed Avago. As sell-side analysts, we’ve followed Avago closely for years. Buried deep inside HP, we know it sells filters that can get into phones, occasionally offering some really interesting but obscure information. Then the spin-off happened.
Editor’s Note:
Guest Author Jonathan Goldberg is the founder of multi-purpose consultancy D2D Advisory. Jonathan develops growth strategies and alliances for companies in the mobile, web, gaming and software industries.
Avago came to life through private equity, and going as far as the origin story is a key clue to what happens next. Avago CEO Hock Tan realized early on what most other semiconductor CEOs didn’t—semiconductor was no longer a growth industry.
The boom years of the 80s and 90s are over, and now the semifinals are competitive, cyclical, and profit margins low. As a result, Avago went on an acquisition spree, acquiring countless companies and driving the stock price up 3,000% (3000%) in 15 years.
The secret to this success is a fairly simple playbook. Acquire a market leader with few competitors. Then spin off segments sold to competing industries, cut overhead and corporate overhead, and drive cash flow — giving more leverage and firepower for the next acquisition. Repeat.
The company has achieved great success in this area and has effectively contributed to the complete consolidation of the US semiconductor industry, from 2000 companies two decades ago to about today There are 200.
The integration process has been exciting for acquired companies. The new management team will eliminate every expense they can find – no more corporate swag, no more free coffee, no corporate IT department, as we all know. For a junior manager who survived the layoffs, it’s fantastic. They are empowered, eliminating bureaucracy, fat option packs and overwhelming workloads.
Another trend has also become apparent over time – companies will significantly reduce R&D, which we will discuss back below. Another important skill for Avago is that its CEO and deal team become experts and find non-financial vehicles that can convince target boards to sell. Sometimes that means retirement agreements for outgoing executives, founders’ positions and titles, or retention of company names. So when they bought Broadcom in 2015, Avago changed its name because that was what was needed to close the deal.
The story goes like this, when Alexander the Great reached the Indus, he sobbed and lamented that there was no more land to conquer. Broadcom entered the Indus River by failing to acquire Qualcomm in 2019 due to a vague last-minute order from the U.S. government from CFIUS. Like all other successful rollup stories, Broadcom needs to keep acquiring bigger businesses to keep the machines running. In 2019, there are really only two companies big enough to push Broadcom forward — Qualcomm and Intel. Qualcomm was out of bounds, and Intel was (at the time) too big to be considered.
So Broadcom turned to a software company. There are many big goals in this field. These companies aren’t necessarily as dominant in the market as Broadcom’s semiconductor targets, but they do have very close relationships with customers locked into long-term contracts and multiple IT dependencies. This means stable cash flow.
In fact, Broadcom is not a semiconductor company. Nor is it a software company. It is a private equity fund that maximizes cash flow through an endless series of acquisitions. This frustrates many in the semiconductor industry and may confuse those in the software industry. This is certainly a challenge for sell-side semi-finished analysts who must now master SaaS metrics. But it’s still a compelling model for shareholders.
What we’ve known about Broadcom over the years is that they’re always on the lookout for new deals. So we can say as a rule of thumb that on the day the VMWare acquisition closes, the banker gets a call asking “What’s next?”
And that’s going to continue how long? Aggregation has several big problems. One is the constant pursuit of new deals we mentioned above. The second is fusion. At some point, these organizations get so large that they start tripping over themselves. Broadcom has largely avoided this problem by delegating so much autonomy to its various divisions, but at some point, it had to get stuck. Especially when everything is under the umbrella of a public company.
Another problem is that the entire model relies on steady cash flow from the underlying business. That’s why private equity firms have long eschewed technology, and the technology risks embedded in these firms are not necessarily present in the more traditional firms that private equity funds typically favor. That’s why we focus on Broadcom’s semiconductor business R&D. There are no obvious flaws today – they are still very strong in networking and dominate the duopoly of cell phone BAW RF filters.
Having said that, we are increasingly hearing from people in the networking business that they are disappointed with the speed at which Broadcom is growing. New chips and features are taking longer and longer to arrive, opening the door for start-ups and in-house solutions in hyperscalers. In RF, there is a real possibility of technological disruption in at least part of the BAW filter market, and Qualcomm and Murata seem to feel strongly about it.
Granted, Broadcom’s team is very smart. If any of their businesses start showing signs of peaking, they won’t hesitate to sell or spin off. Of course, most buyers probably know this, and so far Broadcom hasn’t had a single exit from its portfolio other than the occasional sale of unwanted lines of business post-merger.
For now, Broadcom may still be able to keep this mode going for a long time. There are tons of software targets out there, and they’re all getting cheaper this month. Our best guess is that the only thing that will slow Broadcom down is the energy level of the executive team. Hock Tan is about 70 now, and we’re guessing he has no interest in retiring from growing wine in Napa Valley anytime soon.
