It wasn't long ago that Broadcom (NASDAQ:AVGO), formed when Avago acquired the old Broadcom Corp. in 2016, was entirely focused on semiconductors. After the company's recent acquisitions, that's no longer the case.
The acquisitions of networking company Brocade in 2017 and mainframe solutions provider CA Technologies in 2018 have created a substantial software business within Broadcom. The company expects around 22% of its total revenue to come from software solutions in 2019. That percentage will rise further next year when Broadcom completes its recently announced acquisition of Symantec's (NASDAQ:NLOK) enterprise security business.
Betting on synergy
Broadcom announced on Aug. 8 that it had agreed to pay $10.7 billion in cash for Symantec's enterprise security business. On a pro forma basis, the deal will boost Broadcom's software solutions revenue up to 29% of total revenue. "The addition of Symantec's enterprise security portfolio will significantly expand Broadcom's infrastructure software footprint as it continues to build one of the world's leading infrastructure technology companies," reads Broadcom's press release announcing the deal.
Broadcom expects the new assets to drive more than $2 billion of sustainable run-rate revenues. The company reaffirmed its fiscal 2019 guidance alongside the deal announcement, which calls for revenue of $22.5 billion. Once the deal closes in the first quarter of fiscal 2020, it will boost Broadcom's pro forma annual revenue to $24.6 billion.
The key to this deal for Broadcom is synergy. The stand-alone Symantec enterprise security business is expected to produce about $350 million of earnings before interest, taxes, depreciation, and amortization in fiscal 2019. If that remained unchanged after the acquisition, Broadcom would be paying a staggering 30 times EBITDA.
But Broadcom is only paying a little more than 8 times expected EBITDA, based on its synergy assumptions. Broadcom expects to reduce run-rate costs by $1 billion within 12 months of closing this deal, which would boost run-rate EBITDA of the new security assets to around $1.3 billion. The company plans to reduce costs by eliminating redundancies, refocusing R&D and support efforts to the highest-return-on-investment opportunities, and integrating and rationalizing the sales force. Layoffs, in a word.
Paying for the deal
Broadcom will finance the all-cash acquisition with new committed debt financing, which will add to the mountain of debt Broadcom has accumulated from its various acquisitions. At the end of the fiscal second quarter, Broadcom's total debt had reached $37.5 billion.
Broadcom will stick to its current dividend policy of paying shareholders 50% of prior-year free cash flow, but it's swapping priorities for cash beyond the dividend. Excess cash flow will now be used to pay down debt, with share buybacks taking a back seat. The company intends on maintaining its investment-grade credit rating.
Whether the Symantec deal works out depends on whether Broadcom can successfully cut $1 billion of costs without sacrificing the competitiveness of the products it's acquiring. The enterprise security market has no shortage of competition -- Symantec's security business competes with fast-growing companies like CrowdStrike and Zscaler, as well as larger players like Cisco and FireEye. There may be plenty of fat that can be cut at Symantec's security business, but Broadcom risks going too far and hurting sales as a result.
Broadcom is scheduled to report its fiscal third-quarter results on Sept. 12 after the market closes. Expect management to further flesh out its strategy during the earnings call.