Virtually mine

Hock Tan has bought two software companies in four years, and is now buying a third that is bigger than both put together. On 26 May Broadcom, a maker of chips, said it would pay about $61bn in cash and shares for VMware, a maker of the software that lets one server pretend to be many. It will also take on $8bn of VMware’s net debt.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022} Mr Tan, Broadcom’s chief executive, called it a combination of “our leading semiconductor and infrastructure software businesses”.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022}

Each VMware share can be swapped for $142.50 in cash or 0.2520 Broadcom shares, with about half of the shares paid for in each.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022} On the day before the announcement that was worth $138.23, a premium of 44% to VMware’s price on 20 May, the last day before the talks leaked.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022} Michael Dell, who owns 40.2% of VMware, and the private-equity firm Silver Lake, with another 10%, have agreed to vote in favour.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022} The board of the seller is therefore unlikely to hear a better offer. A 40-day “go-shop” lets it try, until 5 July, and the merger agreement sets a $1.5bn termination fee for VMware, halved to $750m if it takes a superior offer before the go-shop ends.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022,2SEC EDGAR, VMware, Inc. Form DEFA14AAgreement and Plan of Merger between VMware, Inc. and Broadcom Inc.26 May 2022}

The price is steep, and Broadcom’s own sums show why. VMware’s revenue in its latest fiscal year was $12.85bn, up 9%, but its GAAP operating income was $2.39bn, no higher than the year before.^{3SEC EDGAR, VMware, Inc. Form 8-KVMware Announces Fourth Quarter and Fiscal Year 2022 Results24 Feb 2022} Broadcom says it will add about $8.5bn of pro forma EBITDA within three years of closing.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022} The two measures are not identical, so the comparison is rough. It is also hard to ignore: the buyer expects to earn from VMware several times what VMware reports earning from itself.

Mr Tan has done this before. Broadcom paid about $18.8bn for CA Technologies, a mainframe-software firm, in 2018, borrowing $18bn in term loans for the purpose.^{4SEC EDGAR, Broadcom Inc.Form 10-Q for the quarter ended February 3, 201914 Mar 2019} In 2019 it agreed to pay $10.7bn in cash for Symantec’s enterprise security business, and completed the purchase on 4 November.^{5SEC EDGAR, Broadcom Inc. Form 8-KBroadcom to Acquire Symantec Enterprise Security Business for $10.7 Billion (Exhibit 99.1)8 Aug 2019,6SEC EDGAR, Broadcom Inc. Form 8-KBroadcom Completes Acquisition of Symantec Enterprise Security Business (Exhibit 99.1)4 Nov 2019} “M&A has played a central role in Broadcom’s growth strategy,” Mr Tan said then, a remark with the virtue of being true.^{5SEC EDGAR, Broadcom Inc. Form 8-KBroadcom to Acquire Symantec Enterprise Security Business for $10.7 Billion (Exhibit 99.1)8 Aug 2019} After the deal software will account for about 49% of the combined group’s revenue, which should exceed $40bn.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022} A semiconductor company is on its way to becoming a software company, one acquisition at a time.

We have no quarrel with the model in principle. Capital should flow to those who think they can run an asset better, and a buyer who pays a 44% premium is at least putting its own money behind the claim. Nor is this obviously a merger of rivals, so the usual arithmetic of market shares may not bite. Mr Dell, VMware’s chairman, calls the sale “a landmark moment” for the firm.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022}

But the strongest objection is not about market share. It is about leverage. VMware’s customers have built data centres around its products, and moving them is slow and expensive. Broadcom has committed $32bn of new debt to pay for the deal and wants $8.5bn of extra EBITDA.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022} The simplest way to square those two numbers is to charge existing customers more, or to give them less for the same money. The tell is in the description of VMware’s future: Broadcom will fold its own infrastructure and security software into an expanded VMware portfolio, and the whole software group will be renamed VMware.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022} The name, at least, is clearly safe.

Broadcom expects to close within its 2023 financial year, subject to regulators.^{1SEC EDGAR, VMware, Inc. Form 8-KBroadcom to Acquire VMware for Approximately $61 Billion in Cash and Stock (Exhibit 99.1)26 May 2022} Those regulators should therefore ask a question that standard merger tests tend to skip: how easily can a customer leave? Where the answer is “not easily”, a promise of lower prices should be written into the approval, not left to goodwill.

Mr Tan paid for the logo. The customers may yet be asked to pay for the rest.