Broadcom's M&A Savvy, Strategic Vision Give Its Shares More Room to Run

Broadcom (AVGO) is once again doing what it does best: M&A.

As Broadcom turns to yet another multi-billion acquisition, the chipmaker will likely be rewarded for its stellar vision and track record for deal-making, according to company followers. 

Broadcom announced Wednesday, Nov. 2, that it has agreed to acquire Brocade Communications Systems (BRCD) for about $5.5 billion, or $12.75 per share, in cash. The deal includes approximately $400 million of net debt. 

Broadcom, a chip giant formerly known as Avago Technologies that took the name of Broadcom upon its $37 billion acquisition of the semi last year, has largely built its business through M&A. Even as the semi works to digest and integrate its massive $37 billion acquisition, investors had been watching what targets Broadcom could chase after. In fact, anticipation for further M&A has been a contributor to Broadcom's healthy stock performance this year. The stock is up about 25% year-to-date.

Shares of Broadcom rose 1.8% Wednesday morning to $171.78.

While the Brocade acquisition wasn't an intuitive deal -- it has typically gone after pure-play chipmakers instead of network players like Brocade -- it checks all the strategic boxes, said B. Riley analyst Craig Ellis, who has a $215 price target on the stock and a buy rating.

Historically, Broadcom has looked for high market share, rich gross margins, a somewhat concentrated customer base and strong technology intellectual property in its acquisitions, Ellis said, adding that Brocade meets all the criteria.

Going forward, Broadcom shares are well-positioned to continue their run as there's a good number of near-term catalysts.

Early next year, the semi will go into phase two of synergy harvesting for the Broadcom Corp. acquisition and will also move into big product cycles in the wired infrastructure business. Broadcom is scheduled to release new Tomahawk chip products that are poised to gain momentum, Ellis explained.

"The company's had its success pursuing organic and inorganic growth strategy, and as long as it can find deals that are well-aligned with strategic interest then I would expect them to continue to be acquisitive," he added.

With the Brocade deal, Broadcom is signaling that it can be agnostic in M&A, MKM Partners analyst Ian Ing said. It could purchase players in the appliances or components segments rather than pure-play semis.

"It's a clever deal. They went outside their traditional wheelhouse," said Ing, who has a $189 price target and buy rating on the stock.

Shares of Brocade jumped up about 10% Wednesday morning to $12.36.

Broadcom, which has built a track record of smoothly integrating and extracting synergies from its acquisitions, has been harvesting synergies from its acquisition last year. It has also seen its wireless and wired infrastructure segments deliver solid performance.

"The stock has been awarded for some of the positive growth dynamics of the business as well as the synergies of the deal integration," Ellis said. 

Meanwhile, Broadcom did a "splendid job" assuring investors that it was not getting into the systems business with Brocade during the conference call through the planned divestiture of the IP networking business that is anticipated to generate about $1.3 billion in revenue during fiscal year 2018, wrote RBC Capital Markets analyst Amit Daryanani. 

As part of the transaction, the buyer plans to divest the target's IP Networking business that includes Ruckus Wireless Inc. (Brocade purchased Ruckus for $1.5 billion in May). Before its blockbuster deal in 2015, the chipmaker acquired Emulex for $609 million in 2015, PLX Technology for $309 million in 2014 and LSI for $6.6 billion, among others.

Broadcom has been one of the most active participants in the ongoing consolidation of the semi sector where players are rushing to hook up as overall revenue growth as slowed. Just last week, Qualcomm (QCOM) agreed to pay $47 billion for NXP Semiconductors (NXPI) in the biggest semi deal ever. 

NXPI is a holding in Jim Cramer's Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells NXP Semiconductors ? Learn more now.

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