Rumors are swirling that Broadcom wants to buy its way into the growing hybrid cloud market by acquiring VMware. The deal won’t come cheap—after news of the potential deal surfaced, VMware’s market cap soared to around $50 billion. Yes, billion with a ‘B’.
As interest rates increase and investors reevaluate many of the lofty software company valuations, I expect to hear many more acquisition rumors. During this time of uncertainty, cash-flush vendors are going to be on the hunt for software vendors that can provide a technology platform, have large partner ecosystems and that also produce reliable revenue.
Why the Acquisition Makes Sense for Broadcom
Broadcom has a nice, solid business producing semiconductors for smartphone makers as well as storage and networking devices used in large data centers. However, like many hardware companies, the business has been desperately trying to break into the software industry. Why? There’s a semiconductor shortage and the company is in the right market at the right time. However, the company’s leadership knows that market conditions change. Software margins are significantly higher than hardware deals, and R&D and manufacturing costs for semiconductors are notoriously high.
VMware has grown to become a large cloud technology platform, not just a virtualization offering. If Broadcom is able to successfully close on this deal, 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 that the NVIDIA partnership will be a profitable one for VMware. The two companies have been working together to create a platform to support AI-based applications for the data center, cloud and at the edge.
In a time when some cloud businesses are experiencing wild fluctuations because of their lack of profitability, the VMware business model is solid. However, these fundamentals are also why the company is ripe for acquisition. In its fiscal year 2022, the company reported $12.85 billion in revenue and $6.33 billion in subscription and SaaS licensing revenue. Free cash flow for fiscal year 2022 was nearly $4 billion.
Let’s quickly contrast VMware to the cloud data warehouse Snowflake (NYSE: SNOW). Snowflake’s market capitalization is around $40 billion and within the last year was well over $120 billion. Meanwhile, the company’s revenue is around $1.2 billion and it is struggling to find a path to profitability. If you were hunting to acquire a software business during a time when 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 do I say this? The company’s recent acquisitions showed a clear pattern emerging—Broadcom has been trying to acquire its way into software.
In 2018 the company acquired CA Technologies for nearly $19 billion. The following year, Broadcom acquired Symantec’s enterprise cybersecurity business for $10.7 billion. In addition, there were rumors that Broadcom was planning to acquire SAS Institute, the privately held analytics vendor, for somewhere around $15 billion to $20 billion. Those talks fell through when the SAS Institute’s aging co-founders and majority stakeholders announced a plan to go public in 2024.
This M&A strategy might seem strange to many, but Broadcom originally tried growing through the acquisition of companies similar to itself. In 2018, the company made an offer of $117 billion to acquire chip producer Qualcomm. Broadcom later withdrew the bid when it became clear that the Trump administration pushed hard to prevent the deal, citing national security concerns.
Although this latest deal would face governmental review and the Biden administration previously voiced concerns over tech mega-mergers and monopolies, we have not seen the administration prevent similar deals.
The Path Won’t be Easy: Three Strategies for Success
The market is full of cautionary tales of software vendors that were acquired only to be slowly destroyed. A successful acquisition would require Broadcom to tread lightly and maintain the elements that have made VMware the company that it is today. Below are three priorities that Broadcom should focus on if the deal is completed.
Keep VMware independent: It is critical that VMware does not show favoritism toward one chip maker. VMware’s largest customers use chips from Intel as well as other manufacturers. If Broadcom tries to steer VMware toward its own chips exclusively, the backlash could quickly undercut the value of the acquisition. In addition, it’s my belief that the 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 single stack proprietary approaches.
Find innovative DNA and facilitate business unit collaboration opportunities: Hock Tan, Broadcom’s CEO, is very well respected in the industry; however, the company is not known for software innovation. Although 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, like Project Monterey and the NVIDIA partnership, while looking for new investment opportunities. Perhaps Broadcom could provide VMware with custom chips to help accelerate Project Monterey, but this sort of line-of-business collaborative innovation hasn’t been the model for Broadcom’s other software acquisitions. It should be.
Nurture the partnership network: The next phase for 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 solution selling that combines VMware and Broadcom technologies? How can existing Broadcom partners join the VMware partnership ecosystem? That will be another big question.
It will be extremely interesting to see how this plays out. We’ll definitely be keeping an eye on this potential merger of two heavyweights!