According to Reuters, the UK’s competition regulator provisionally approved U.S. technology company Broadcom’s $69 billion takeover of VMware on Wednesday, stating that the deal would not weaken competition in the supply of key computer server products.
The Competition and Markets Authority (CMA) gave its provisional approval for Broadcom’s largest-ever acquisition after Broadcom offered interoperability remedies to some competitors to address concerns. This follows the EU regulator’s approval of the acquisition last week.
“After reviewing the evidence collected from Broadcom, VMware, and other relevant parties, the independent CMA panel has provisionally found that the transaction will not substantially reduce competition in the supply of server hardware components in the UK,” the CMA stated.
The proposed transaction highlights chipmaker Broadcom’s goal of diversifying into the enterprise software sector, but at the same time, global regulators have increased their scrutiny of large technology company deals.
In March, the UK regulator had expressed concerns that the deal could make servers more expensive and said it would now consult on its provisional approval before publishing a final report by September 12.
Broadcom welcomed the unconditional approval and stated that it expects to complete the transaction this fiscal year.
The CMA stated that it had explored concerns that the deal could harm the competitive ability of Broadcom’s rivals if the combined company’s products worked less effectively with VMware’s server virtualization software.
The “(CMA) panel believes that the transaction is unlikely to harm innovation, particularly because information about new product adjustments would only need to be shared with VMware at a stage too late to bring commercial benefits to Broadcom”.
The $69 billion deal, which includes $61 billion in equity and the rest in debt, is also under review by the U.S. Federal Trade Commission.
This year, the CMA became the first major regulator to block Microsoft’s acquisition of “Call of Duty” maker Activision Blizzard, but it has since said it may reconsider a revised proposal. The parties are currently working to resolve the dispute.
The World’s Largest Semiconductor Acquisition Makes Significant Progress #
According to Bloomberg, Broadcom’s $61 billion acquisition of cloud computing company VMware Inc. is nearing approval from EU merger officials, paving the way for what would be the world’s largest-ever semiconductor manufacturer acquisition.
According to sources who wished to remain anonymous, the European Commission could express its consent as early as Wednesday, after months of negotiations with the companies. During the talks, Broadcom signed behavioral remedies, including a commitment to introduce interoperability standards into its technology to allow competitors to compete more fairly.
The Financial Times noted that four people familiar with the matter said the EU’s executive body, the European Commission, would announce on Wednesday that it had accepted Broadcom’s concessions, which would ensure that VMware’s software remains compatible with competitors’ hardware. These sources stated that this measure proved sufficient to resolve the EU’s competition authorities’ concerns without Broadcom needing to sell off parts of the VMware business.
Previously, the EU had investigated the $61 billion acquisition of VMware by chip and device maker Broadcom. According to the EU’s initial findings, the acquisition could lead to Broadcom’s network and storage competitors being unable to obtain VMware software or having their hardware become incompatible with VMware.
After Broadcom announced its plan to buy VMware for $61 billion and said its own divisions, including infrastructure and security software, would be renamed VMware, the news drew attention from the EU. Some VMware users, based on Broadcom’s “dark history” of acquiring CA and Symantec, also worried they might be forced to buy Broadcom hardware in the future.
The EU received a notification of the acquisition last year and the European Commission launched an investigation. The preliminary findings of the investigation showed that the deal could allow Broadcom to restrict competition in the network and storage markets. The commission believed this could reduce the compatibility of VMware’s server virtualization software with competitors’ hardware, shift it to favor Broadcom’s hardware, or prevent rival hardware from using VMware software or reduce its access to it, thereby excluding competitors. These scenarios would lead to increased prices, reduced quality, and a negative impact on innovation for corporate customers, ultimately harming consumers.
Furthermore, the European Commission also investigated whether Broadcom’s acquisition of VMware would affect other vendors’ development of SmartNICs. In 2020, VMware and three SmartNIC vendors (Nvidia, Intel, and AMD) launched Project Monterey.
The EU stated at the time that if Broadcom acquired VMware, it might restrict VMware’s participation in Project Monterey to protect its own network card revenue and prevent technological innovation. The EU also considered whether Broadcom would begin bundling VMware virtualization software with its own software (primarily mainframe and security software) instead of selling VMware separately, leading to reduced market choices and the exclusion of competing software suppliers.
The report stated that while Brussels regulators would approve the deal, along with their counterparts in Canada, Brazil, and South Africa, the acquisition still faces competition investigations in the United States, the United Kingdom, and China.
The deal had previously faced strict scrutiny, with the commission highlighting in April the potential reasons for blocking the deal unless there were sufficient remedies. The company warned that the deal could lead to “price increases, quality reductions, and less innovation” for enterprise customers.
The UK’s Competition and Markets Authority is set to release the interim findings of its investigation into the record-breaking Broadcom deal later this month, with a statutory deadline of September 12. The UK regulator has found itself increasingly isolated in its review of technology deals, taking a tougher stance on companies’ future behavioral commitments, such as in its investigation into Microsoft’s $69 billion acquisition of Activision Blizzard.
Broadcom Is No Longer a Semiconductor Company! #
Broadcom’s existence originated from a spin-off. About twenty years ago, HP began its process of miniaturization. First, it spun off Agilent, which contained a hodgepodge of businesses unrelated to PCs or printers. Agilent, in turn, split itself into several parts, one of which was HP’s former internal chip business, renamed Avago. As sell-side analysts, we closely followed Avago for many years. Buried deep within HP, we knew it sold filters that went into mobile phones and occasionally provided some very interesting but obscure information. Then the spin-off happened.
Avago came to life through private equity, which is a key clue to what would happen next. Avago CEO Hock Tan realized early on what most other semiconductor CEOs didn’t: the semiconductor industry was no longer a growth industry.
The boom of the ’80s and ’90s had ended, and now the semiconductor industry was fiercely competitive, highly cyclical, and had low-profit margins. So, Avago began a frantic series of acquisitions, buying a countless number of companies and driving its stock price up by 3,000% over 15 years.
The secret to this success was a fairly simple playbook. Acquire companies that are market leaders with few competitors. Then, spin off segments that are in competitive industries, cut management and corporate overhead, and drive cash flow—which provides more leverage and firepower for the next acquisition. And then repeat.
The company has been hugely successful at this and has effectively facilitated a complete consolidation of the American semiconductor industry, which has gone from 2,000 companies 20 years ago to around 200 today.
For the acquired companies, the integration process is brutal. The new management team will eliminate all the expenses they can find—no more company memorabilia, no more free coffee, and notoriously, no corporate IT department. For junior managers who survived the layoffs, it was great. They were given autonomy, with bureaucracy eliminated, rich stock packages, and heavy workloads.
Over time, another trend also became apparent—the company would significantly reduce R&D, and we will return to this topic below. Another important skill of Avago was that its CEO and deal team became experts at finding non-financial tools to persuade target boards to sell. Sometimes this meant retirement agreements for departing executives, positions and titles for founders, or the retention of the company name. Thus, when they acquired Broadcom in 2015, Avago changed its name because it was a necessary condition to complete the deal.
The story is that when Alexander the Great reached the Indus River, he sobbed, lamenting that there were no more lands to conquer. Broadcom entered its “Indus River” in 2019 after a vague, last-minute order from the U.S. government’s CFIUS prevented it from acquiring Qualcomm. Like all other successful rollup stories, Broadcom needs to continuously acquire larger businesses to keep the machine running. By 2019, there were only two companies big enough to drive Broadcom forward: Qualcomm and Intel. Qualcomm had failed, and Intel was (at the time) too big to consider.
So Broadcom turned to software companies. There are many big targets in this area. These companies aren’t necessarily as dominant in their markets as Broadcom’s semiconductor targets, but they do have very close relationships with customers who are 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 people in the software industry. For sell-side semiconductor analysts who now have to master SaaS metrics, it is certainly a challenge. But for shareholders, it remains a compelling model.
One thing we’ve learned about Broadcom over the years is that they are always looking for new deals. So we can say from experience that on the day the VMWare acquisition closes, the bankers will get a call asking, “What’s next?”.
How long can this situation last? Rollups have several big problems. One is the constant pursuit of new deals that we mentioned above. The second is integration. At some point, these organizations become so large that they start to trip over themselves. Broadcom has largely avoided this problem by delegating so much autonomy to its various divisions, but at some point, this has to run into trouble. Especially when everything is under the umbrella of a single public company.
Another issue is that the entire model relies on stable cash flow from the underlying businesses. This is why private equity firms have long avoided technology, which has technological risks that are not necessarily present in the more traditional companies that private equity funds typically favor. This is why we are concerned about the R&D of Broadcom’s semiconductor business. There are no obvious flaws today—they are still very strong in the networking space and are the dominant party in the duopoly around mobile BAW RF filters.
That said, we are increasingly hearing from people in the networking business that they are disappointed with the pace of Broadcom’s development. It is taking longer and longer for new chips and features to arrive, which opens the door for startups and internal solutions in hyperscale enterprises. In the RF space, there is a real possibility of a technological disruption in at least part of the BAW filter market, and Qualcomm and Murata seem to have strong feelings about this.
Admittedly, Broadcom’s team is very savvy. But if any of their businesses start to show signs of peaking, they will not hesitate to sell or spin it off. Of course, most buyers probably know this, and so far, apart from the occasional post-merger sale of an unpopular business line, Broadcom has not exited a single one of its portfolio investments.
As things stand, Broadcom can probably make this model last for a very long time. There are a huge number of software targets out there, and they all got cheaper this month. Our best guess is that the only thing that could slow Broadcom down is the energy level of the executive team. Hock Tan is now around 70 years old, and we guess he has no interest in retiring to grow wine in Napa Valley anytime soon.