Broadcom buys VMware and that may bring changes to the cloud industry

Broadcom recently announced it is acquiring VMware. This will be the third-largest tech acquisition in history once the deal is completed. And it could bring changes to the entire cloud industry and even IT as a whole.

Broadcom isn’t hiding its long-term goals. The company wants to become the biggest player in IT infrastructure and has been making strategic moves for several years. Now it seems it’s getting more and more close to that goal. Would this reflect on the cloud industry? Most likely. Let’s explore what happened, the future of VMware, the industry’s possible changes, and what it will mean for other players.

Broadcom’s big deal

On May 25^th, 2022 Broadcom announced it is buying VMware for a little bit more than $61 billion. This is a hefty premium over VMware’s stock price at the time of the announcement of the deal – more than double. This makes it the third-largest tech deal in history behind Microsoft’s pending acquisition of Activision Blizzard for $69 billion and Dell’s purchase of EMC for $67 billion in 2016. Broadcom will also inherit about $8 billion in debt which does not factor into this statistic.

“Building upon our proven track record of successful M&A, this transaction combines our leading semiconductor and infrastructure software businesses with an iconic pioneer and innovator in enterprise software as we reimagine what we can deliver to customers as a leading infrastructure technology company”, Hock Tan, President and Chief Executive Officer of Broadcom, said in a release.

Michael Dell and Silver Lake, which own 40.2% and 10% of VMware shares outstanding, respectively, have signed support agreements to vote in favor of the transaction, so long as the VMware Board continues to recommend the proposed transaction with Broadcom, the release also says.

What will happen with VMware now?

“Following the closing of the transaction, the Broadcom Software Group will rebrand and operate as VMware, incorporating Broadcom’s existing infrastructure and security software solutions as part of an expanded VMware portfolio”, Broadcom explained.

This means VMware will continue to exist basically with a new owner. It’s a similar proposition as it was when VMware was owned by Dell. Interestingly enough, VMware was spun off from Dell last year. It was an effort to pay off debt. VMware became part of Dell with the EMC deal in 2016 and Dell founder Michael Dell is the biggest shareholder in VMware. He also serves on the board of directors of the company. According to Financial Times, he can earn up to $24 billion from the deal.

“Together with Broadcom, VMware will be even better positioned to deliver valuable, innovative solutions to even more of the world’s largest enterprises. This is a landmark moment for VMware and provides our shareholders and employees with the opportunity to participate in the meaningful upside”, Michael Dell says in a release.

The actual deal will combine a stock and cash payment. Broadcom has obtained new debt financing from a consortium of banks for $32 billion. Upon closing the transaction, based on each company’s outstanding shares as of the date hereof, current Broadcom shareholders will own approximately 88% and current VMware shareholders will own approximately 12% of the combined company.

What’s interesting is that the agreement offers a “go-shop” provision, too. It means that VMware is free to look for proposals from other potential buyers. It has a 40-day period during which it can do so. If someone comes forward with a superior proposition, VMware will be free to accept it. Analysts though don’t seem to expect such a development. MarketWatch notes that the deal has already been signed off by the boards of both companies and only the shareholder vote is left. The stock markets also liked the deal by raising the prices a bit for both companies.

Broadcom is in the clouds

Broadcom is very generous with its details about what it expects from VMware. The company has a long statement about it:

“By bringing together the complementary Broadcom Software portfolio with the leading VMware platform, the combined company will provide enterprise customers with an expanded platform of critical infrastructure solutions to accelerate innovation and address the most complex information technology infrastructure needs. The combined solutions will enable customers, including leaders in all industry verticals, greater choice and flexibility to build, run, manage, connect and protect applications at scale across diversified, distributed environments, regardless of where they run: from the data center, to any cloud and to edge-computing. With the combined company’s shared focus on technology innovation and significant research and development expenditures, Broadcom will deliver compelling benefits for customers and partners.”

Even if it’s mostly PR talk, it also clearly states Broadcom’s goals and ambitions: It wants to expand and diversify its core business. We know Broadcom mostly for its semiconductor work, but the company has been making strategic acquisitions for a few years now and all of them are setting it up for the future. For example, it bought CA Technologies for $18.9 billion in 2018. Then it also purchased Symantec for $10.7 billion in 2019. It is clear that the company works toward a future where Broadcom is an IT giant with significant pull in enterprise software and cloud computing.

“We would not be surprised if AVGO (Broadcom’s ticker on the stock market) bought VMWare given its history of software acquisitions, and the deal would likely be accretive. However, we believe the accretion would be offset by a decline in AVGO multiple given the ‘conglomerate discount’ that acquisitive semiconductor companies get and the fact that VMWare has much lower margins than AVGO”, wrote Citi analyst Christopher Danel, quoted by Barron’s.

Tracy Woo, senior analyst at Forrester, on the other hand, sees that with the acquisition Broadcom was looking for “avenues outside of its traditional semiconductor business and into enterprise software”. And it makes sense because the chip market has been quite rough during the past few years which is making players like Broadcom look to diversify their revenue streams.

On paper, the recent acquisitions lay a solid foundation for Broadcom. It now has massive talent and resource power for DevOps, enterprise software, cybersecurity, virtualization and cloud solutions. And all of those are “things” which are in massive demand right now and will continue to be in such for a long time. So, positioning itself as a leader in the area technically guarantees Broadcom a bright future.

What changes we can expect

Well, if the deal is finalized, the cloud industry will instantly gain a major new player. VMware has more than 500 000 customers and has established partnerships with all of the major cloud providers, The New York Times notes. It’s rumoured that there are more deals on the horizon from various players, including private equity firms.

This is somewhat of a natural process when we consider such a big move. It will be followed by a “rearrangement of the layers” in the industry.  Other players will now seek to also strengthen their positions to be able to better compete with this new force that’s suddenly entering the field.

It’s also important to note that VMware was especially active in the weeks leading to the deal. The company announced that its VMware Sovereign Cloud initiative grew to 14 participants. This is a project that helps customers identify and engage with trusted national or regional cloud service providers to meet their unique sovereign cloud requirements. And it now features participants in 14 major countries around the world. It also announced new data services for its VMware Cloud provider offerings.

It also doubled down its multi-cloud strategy and its partnerships for data protection and security offerings. And VMware’s CEO Raghu Raghuram gave a big interview to Protocol in which he laid out a lot of the company’s goals and plans along with its “realignment”. All of this showed us that VMware is here to stay and expand its efforts in a rapid fashion. And now it will have (when the deal is completed) an even more powerful backing from Broadcom’s other resources along with the big ambitions of the new owner. So, we can safely expect that VMware will become even more active to try and fulfil the expectations.

Customers should be the big winners as it will mean even more competition in an already very dynamic segment. That is if regulators don’t get a bit concerned about the big mergers that are happening. One could argue that this deal doesn’t significantly change the cloud industry in terms of consolidation as the new owner wasn’t a big player in the niche.

We also have Hock Tan, CEO of Broadcom. He’s very ambitious about turning his company into an unstoppable IT force. Financial Times reported that Hock has had a very strict process and goal. “Hock did not become an acquirer until he had a very firm grasp of the granular microeconomics of how to run a scaled semiconductor business,” said a person close to the entrepreneur”, FT notes.

Only then did Hock start to work on expanding Broadcom. He had a failed deal to buy Qualcomm for $142 billion, but that didn’t stop him. He instead refocused on expanding into other niches. FT also says he is a cost-cutter and doesn’t like to spend money unless it’s needed.  FT’s informers say Tan wants to make VMware nearly twice as profitable as it is. So, that’s going to be a very interesting challenge to see.

And not everyone is convinced it will happen. MarketWatch comments on such a deal like this: “An acquisition by Broadcom is not exactly a big endorsement of VMware’s cloud-based future”. It also says that “Broadcom has made it a practice of buying older, forgotten software companies”. But VMware was not forgotten. It has a steady business and while not as glamorous like some other cloud companies, it’s still well respected and contracted by all of the top players.

So, while Broadcom may not seem like a good fit for VMware, VMware is a great fit for Broadcom. That is if it manages to make the most out of its new purchase. For that to happen it will have to trust its judgement and help achieve it instead of bossing it around. If they keep their promise about creating an inspirational culture that fosters innovation, the cloud industry will change big time. Or… we may end up with another Microsoft-Nokia moment and that won’t be good for anyone in the long term.