Back in July, chip giant Broadcom (AVGO -0.17%) announced that it'd be forking over a cool $18.9 billion to acquire mainframe software company CA Technologies. On Broadcom's Dec. 6 earnings conference call, CEO Hock Tan explained just how the company planned to milk this acquisition to generate significant profits for its shareholders.
The plan is a compelling one. Let's take a closer look at what exactly Broadcom intends to do.
Image source: Getty Images.
Reshaping the business
Tan explained during Broadcom's most recent earnings call that the company will be making "substantial changes" to CA Technologies' business model now that it's under Broadcom's control.
First, the executive said that "gone are the days of trying to land new products with new customers" in enterprise software. "We are focusing all our attention on renewing existing products with existing mainframe-centric customers, customers that represent virtually all of the world's largest enterprises and largest spenders on [information technology]," Tan proclaimed. "We are also targeting expansion opportunities within this core mainframe customer base."
"This new business model, we believe, plays to our strengths, focusing on the largest 500 customers tied to mainframes with the ability to up-sell enterprise software competitively using an all-you-can-eat subscription based model," the executive elaborated.
That sounds nice, but what will this mean for the company's financials?
Costs decline, profits rise
When all is said and done, Tan expects revenue from the newly restructured CA Technologies to "stabilize at over $3.5 billion annually and grow from there."
That's actually down from the roughly $4.24 billion that it generated as a stand-alone entity in fiscal 2018, but as you'll soon see, this should actually be a good move for shareholders.
Some of those restructuring steps, he explained, include the divestiture of application security testing company Veracode (which Broadcom acquired as part of its purchase of CA Technologies), for $950 million as well as "the outsourcing of the CA services business to HCL." (That agreement was announced on Dec. 3.)
In fiscal 2018, CA Technologies reported that revenue from professional services was $311 million while the cost of those services was $298 million. It's not hard to see why Broadcom, in a bid to maximize CA Technologies' profitability, would choose to outsource those services.
While CA Technologies' revenue stands to drop as a result of all that restructuring, Tan said that "to support that revenue base, we do not expect to spend more than $900 million per year."
For some perspective, here's a breakdown of some of CA Technologies' key operating expenses in fiscal 2018:
| Expense | Cost (in Millions) |
|---|---|
| Selling and marketing | $1,061 |
| General and administrative | $406 |
| Product development and enhancements | $642 |
Data source: CA Technologies earnings release.
The three line items above cost CA Technologies more than $2.1 billion in its fiscal 2018, so if Tan's plan is successful, CA Technologies' cost structure will be slashed by more than half while retaining the vast majority of its revenue.
"[As] a result, we expect to achieve more than $2.5 billion per year in profitability from the CA business once we go through this transition," said Tan. As a stand-alone entity, CA Technologies only took in $1.119 billion in operating income during fiscal 2018.
Investor takeaway
Ultimately, if Broadcom is successful on delivering on what Tan outlined to investors, then not only will CA Technologies' shareholders have benefited (Broadcom bought the company for a 20% premium), but Broadcom's shareholders should stand to profit handsomely from it, too.
Broadcom paid $18.9 billion for CA Technologies, $950 million of which it just recouped from selling off Veracode. Indeed, if this business can make at least $2.5 billion per year in operating profit, then it won't be terribly long before this acquisition will have paid for itself.
Only time will tell, but after hearing Tan's big picture plan for CA, it's not hard to think that this acquisition will be a success, ultimately creating significant value for Broadcom's shareholders. The big question on my mind now with respect to Broadcom is, "What will it acquire next?"
