Rumors are circulating that Broadcom wants to make its way into the growing hybrid cloud market by acquisition of VMware. The deal won’t come cheap – after the announcement of the potential deal, VMware’s market cap soared to around $50 billion. Yes, billion with a ‘B’.
As interest rates rise and investors reprice many of the lofty software company valuations, I expect to hear many more takeover rumours. During this time of uncertainty, cash-strapped vendors are going to be looking for software vendors that can deliver a technology platform, have large partner ecosystems, and generate reliable revenue.
Why the acquisition makes sense for Broadcom
Broadcom has a nice and strong business producing semiconductors for smartphone makers as well as storage and networking devices used in large data centers. However, like many hardware companies, the company desperately tried to break into the software industry. Why? There is a shortage of semiconductors and the company is in the right market at the right time. However, company management knows that market conditions are changing. Margins on software are significantly higher than hardware deals, and semiconductor R&D and manufacturing costs are notoriously high.
VMware has grown to be a great cloud technology platform, not just a virtualization offering. If Broadcom is able to complete this deal successfully, it will instantly own one of the largest cloud software platforms in the industry. In addition to acquiring large enterprise customers, the VMware partner ecosystem is important. For example, I believe the NVIDIA Partnership will be profitable for VMware. The two companies worked together to build a platform supporting AI-powered applications for the data center, cloud, and edge.
At a time when some cloud companies are experiencing wild swings due to lack of profitability, VMware’s business model is solid. However, these fundamentals also explain why the company is ripe for acquisition. In its 2022 fiscal year, the company recorded $12.85 billion in revenue and $6.33 billion in subscription and SaaS license revenue. Free cash flow for fiscal year 2022 was nearly $4 billion.
Let’s quickly compare VMware to the Snowflake (NYSE: SNOW) cloud data warehouse. Snowflake’s market capitalization is around $40 billion and last year it was well over $120 billion. Meanwhile, the company’s revenue is around $1.2 billion and it’s struggling to find a path to profitability. If you were looking to acquire a software company in an era where financial indicators are flashing red, which business model would you prefer?
Broadcom’s Strategy: Become a Software Company
I mentioned that Broadcom is desperate to gain relevance in the software industry. Why am I saying this? The company’s recent acquisitions have shown a clear pattern emerging – Broadcom has been trying to make its way into software.
In 2018, the company acquired CA Technologies for nearly $19 billion. The next year, Broadcom has acquired Symantec’s enterprise cybersecurity business for $10.7 billion. Additionally, there were rumors that Broadcom was plans to acquire SAS Institute, the private analytics provider, for about $15 billion to $20 billion. Those talks fell apart when SAS Institute’s aging co-founders and majority shareholders announced a plan to go public in 2024.
This M&A strategy may seem strange to many, but Broadcom initially tried to grow by acquiring companies similar to itself. In 2018, the company made a $117 billion bid to acquire chipmaker Qualcomm. Broadcom then withdrew the offer when it became clear that the Trump administration had done everything possible to prevent the deal, citing national security concerns.
While this latest deal is under government scrutiny, and the Biden administration has previously raised concerns about mega-mergers and tech monopolies, we haven’t seen the administration prevent similar deals.
The Road Won’t Be Easy: Three Strategies for Success
The market is full of cautionary tales from software companies that have been acquired only to be slowly destroyed. A successful acquisition would require Broadcom to tread carefully and retain the elements that made VMware the company it is today. Below are three priorities Broadcom should focus on if the deal goes through.
Keep VMware independent: It is essential that VMware does not show favoritism towards a chipmaker. VMware’s largest customers use chips from Intel as well as other manufacturers. If Broadcom tries to steer VMware towards its own chips exclusively, the backlash could quickly reduce the value of the acquisition. Also, I think hybrid and multi-cloud models are here to stay (rather than a single cloud approach). Customers expect vendors to work with each other and are reluctant to accept proprietary, single-stack approaches.
Find innovative DNA and facilitate collaboration opportunities between business units: Hock Tan, CEO of Broadcom, is highly respected in the industry; however, the company is not known for software innovation. While I expect VMware to remain a standalone business unit (similar to CA’s current position within Broadcom’s ecosystem), it will be important to foster innovation. Broadcom should accelerate VMware investments, such as the Monterey project and the NVIDIA partnership, while looking for new investment opportunities. Broadcom might be able to supply VMware with custom chips to help accelerate Project Monterey, but this kind of collaborative business innovation has not been the model for Broadcom’s other software acquisitions. It should be.
Feeding the network of partners: The next phase of the VMware partner ecosystem will require partners to understand the company’s vision for the future. What will the acquisition mean for partners? Will they have access to more retail solutions that combine VMware and Broadcom technologies? How can existing Broadcom Partners join the VMware Partner Ecosystem? This will be another big question.
It will be extremely interesting to see how this plays out. We will certainly keep an eye on this potential merger of two heavyweights!