Broadcom/VMware: mature software stars are cash cows for the downturn

VMware added billions to Michael Dell’s fortune. Hock Tan hopes it will do the same for him. Broadcom, the US tech group Tan runs, is closing in on a blockbuster acquisition for the cloud business that could value it at more than $50bn.

Buying VMware would complete the transformation of Broadcom. Tan has turned this semiconductor roll-up into a stable of mature software stars with mediocre growth but impressive cash generation.

In the last two years, Broadcom shares have risen 82 per cent, well ahead of the S&P 500, giving Tan credibility for his biggest gambit yet. It would be no surprise if Dell goes along for the ride.

VMware pioneered so-called virtualisation software for corporate customers. It has evolved into a mature tech vendor providing a bridge for large companies that want to move data from on-site centres to the cloud. When Dell’s eponymous tech group acquired data storage provider EMC in 2016 for $62bn, EMC’s crown jewel asset was its supermajority stake in VMware.

The Trump administration quashed Broadcom’s attempt to buy chip rival group Qualcomm in 2018. Tan pivoted to acquire CA Technologies and the enterprise security unit of Symantec, spending $30bn. His hunch was that corporate relationships with legacy software groups would persist for years, even as operations migrated to the cloud.

Broadcom was able to cut costs and cross-sell products and services. Its gross margin has risen to 75 per cent from 63 per cent four years ago. Free cash flow has more than doubled.

VMware’s lot has been that of a pawn in a bigger game, first as an affiliate of EMC and then of Dell. The latter spun off its stake to its investors last autumn. That left Michael Dell personally as VMWare’s largest shareholder.

Dell has himself transformed his legacy hardware company into an enterprise software powerhouse through M&A. Traditional equipment makers had fallen from favour with investors. They prefer high-growth SaaS and cloud companies. Value tech is the focus of vulture funds and listed consolidators such as Broadcom and Dell.

As interest rates rise and high-fliers plummet to earth, companies focused on high margins and efficiencies may come back into favour. Broadcom, which has an enterprise value of $250bn, will probably have to offer its own shares to VMware shareholders. Michael Dell’s association with the business may be far from over.

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Source: Financial Times