What Is VMware (VMW) Worth If The Broadcom (AVGO) Deal Fails?

It has been nearly one yr since Broadcom (NASDAQ:AVGO) introduced its supposed Blockbuster acquisition of VMware (NYSE:VMW) for $69 billion enterprise worth ($61 billion for the fairness and assuming $8 billion of VMware internet debt). The inventory proper now trades at a 12% low cost to the buyout provide. In mild of the current block from the UK for the Microsoft (MSFT), Activision Blizzard (ATVI) deal, it is sensible to entertain a state of affairs the place the deal would not undergo and what that might imply for each corporations.

MSFT ATVI deal

The MSFT ATVI deal has been a fiercely fought battle over the past yr with regulators worldwide. Now the UK has blocked the provide and one other spherical of authorized actions are forward as Microsoft intends to struggle this deal. If the settlement fails, ATVI will obtain round $3 billion in termination charges from Microsoft. Though the deal has seen way more scrutiny than the AVGO VMW deal, it’s nonetheless price contemplating what would occur if it falls by way of. The market now assigns a much less negligible threat to the deal breaking (12% low cost for VMW versus 20% low cost for ATVI). If it falls by way of, VMW will obtain $1.5 billion in termination charges from AVGO.

VMware earlier than the deal

Within the image beneath, we are able to see the historic worth, valuation and progress of VMware. The inventory just lately acquired spun out of Dell Applied sciences (DELL) in late 2021, so the acquisition of Broadcom comes very early within the public lifetime of the corporate. We are able to see that Broadcom made its bid when the inventory was buying and selling at an all-time low of $93, providing an enormous premium of over 40% for the inventory ($142.5 per share). For shareholders of VMware, this can be a profitable provide and it’s comprehensible why the deal acquired accepted by shareholders of each corporations.

VMware’s fundamentals

If we have a look at the previous 5 years for VMware, we are able to see that the corporate noticed stable progress, with revenues rising 11% on common. Profitability has been missing behind. With its shift to subscription and SaaS income from Licenses, VMW expects to extend its working margin to 30%. This could assist speed up earnings progress. In line with information from Looking for Alpha, the corporate targets a ten% income CAGR, with analysts anticipating barely decrease progress.

Implications for Broadcom

In a earlier article on Broadcom, I outlined what I anticipate the vary of earnings potential to be for the corporate. Apart from the M&A threat from the VMware deal, I included the Apple (AAPL) threat: Apple is a big a part of Broadcom’s income (20%) and there are rumors that the corporate is seeking to develop its personal chips. Whereas I don’t consider it to be a big menace, I needed to entertain the thought nonetheless. Relying on the deal and attainable (regardless that unlikely) lack of Apple’s enterprise, I got here to a spread of $15.8-$27.8 billion in EBITDA (round $3 billion in danger from Apple and $3-$8.5 billion from the merger relying on the cost-cutting measures) and used an 85% FCF conversion fee between $13.4-23.6 billion in Free Money Movement. This leaves a big selection of attainable outcomes, however I am going to use the reported FCF numbers for the next valuations for each corporations.

Each shares look low cost

To worth each corporations, let us take a look at an inverse DCF mannequin. I calculate it utilizing reported Free Money Movement and Proprietor Earnings, which I outline as:

FCF + Progress CapEx – SBC +/- Adjustments in Web Working Capital

We are able to see that VMware has fairly a little bit of stock-based compensation in comparison with its Free money flows (1/3). Progress CapEx will be largely ignored as each corporations aren’t heavy spenders on CapEx. Adjustments in NWC distort FCF considerably, however not meaningfully. I added $1.5 billion to this valuation mannequin’s money steadiness from termination charges. With these numbers, VMware must develop its Proprietor Earnings by 9% for the subsequent 5 years, adopted by 5% for the subsequent 5 years after that. This appears achievable if we contemplate Analyst expectations of Income progress within the excessive single digits on common and the plan to extend working margins from the SaaS transition. VMW appears moderately priced, so I would not anticipate the inventory to drop too considerably even when the deal falls by way of. At 6% EV FCF yield and 11 occasions ahead EBITDA, the corporate is priced cheaply on a a number of foundation as nicely.

For Broadcom, we are able to see that SBC will not be as a lot of an issue. Adjustments in NWC distorted Free money circulation much more than for VMware. Progress CapEx will not be related right here; Broadcom outsources most of its manufacturing. I additionally included the termination charge for this state of affairs the place the deal falls by way of. This time it’s subtracted from the money steadiness. Broadcom must develop proprietor earnings at 5% for the subsequent 5 years, adopted by 3% over the subsequent 5 years after that. This aligns with Analyst income progress expectations for the next years and leaves room for the upside from margin optimization.

Conclusion

Each corporations appear to be a great deal at these ranges, even when the deal falls by way of: VMware shouldn’t fall an excessive amount of, given their fundamentals and honest valuation. They might additionally obtain $1.5 billion (2.5% of the enterprise worth) in termination charges. Over the short-term, I might assume the inventory to fall whether it is terminated from individuals promoting out of the merger arbitrage positions, however that ought to rebound given the valuation. Broadcom would not be a lot impacted by the termination charges and even with out the deal, it appears pretty priced, given its valuation and modest progress expectations.