Broadcom eyes $50B takeover of VMware – reports

Ageing IT giants with hardware origins have long been attracted to younger software companies, especially those exuding the powerful aroma of the cloud. Making money in hardware means cranking out expensive new gadgetry year after year and persuading customers they need it. The business of software subscriptions is more like renting out a property. After the initial hard work is done, profit margins are often better.

The rationale behind so many of this century's hardware-meets-software stories could largely explain why Broadcom, a huge semiconductor firm, is rumored to be in talks about a $50 billion takeover of VMware, a cloud-computing software specialist on the rebound from a five-year relationship with Dell. VMware would give Broadcom another skillset and a recurring source of revenues, pleasing investors who think diversification is important. But demand for its software could also help Broadcom sell more chips.

Figure 1: VMware share price ($) (Source: Google Finance)

VMware was snapped up by Dell in 2016 as part of the PC and server maker's $67 billion takeover of EMC, an IT company that bought VMware way back in 2003 for just $635 million. To many observers, it was the most eye-catching part of EMC at the time of the Dell acquisition, providing software and tools for managing workloads in the cloud. Yet the relationship was not destined to last. Burdened by nearly $40 billion in total debt, Dell completed a VMware spinoff last November, although founder Michael Dell is still thought to own a substantial chunk.

Now valued at about $40 billion on the stock market, VMware is reported to have caught the attention of Hock Tan, Broadcom's CEO, whose tastes appear to have changed considerably. In 2018, he was thwarted in his efforts to buy Qualcomm, a semiconductor rival, by Donald Trump. The former US president blocked the deal on grounds of national security, apparently believing Broadcom is too close to China. Four years later, the Broadcom boss seems drawn to software instead.

Any cloud you like

A takeover would net a business that made nearly $13 billion in revenues last year and about $1.8 billion in profit. Essentially, VMware provides a platform for hosting and managing IT and network resources in private and public clouds, or a mix of the two. A selling point is VMware's ability to shapeshift and accommodate various cloud demands. It boasts working relationships with all the big public clouds – AWS, Google Cloud and Microsoft Azure – and claims to have tie-ups with as many as 4,500 other cloud providers across 120 countries.

This versatility could also make it an appealing "abstraction layer" for customers worried about tying themselves to a single cloud. Dish, a US company building a fourth US mobile network, has kept VMware in its mix of suppliers despite striking a comprehensive cloud deal with AWS. The critical software that supports Dish's radio access network will sit on VMware's platform, not directly on AWS.

Want to know more about 5G? Check out our dedicated 5G content channel here on Light Reading.

Clever marketing of VMware could also boost sales of Broadcom chips. The cloud has previously meant hosting IT resources at big data centers far away from many of the end users. In what the industry refers to as "edge computing," these resources are increasingly being deployed in numerous smaller facilities for performance and security benefits. Those will obviously need kitting out with servers and silicon. Global investment in 5G and edge computing means five times as much silicon may be needed in future, said Darrell Jordan-Smith, the senior vice president of global industries for Red Hat, a VMware rival, at a recent press briefing.

One doubt is that interest in VMware's products will translate directly into additional chip sales for Broadcom. VMware's most prominent chip partner today is Intel, whose CEO Pat Gelsinger ran VMware before he took charge of the semiconductor giant in February last year. But ownership by any hardware player makes VMware appear less independent – a factor that was always problematic when it was a Dell subsidiary.

Less-than-stellar growth

VMware's recent sales growth has also been less than impressive, averaging 13% annually over the last five years. The comparable rate for Red Hat (itself a part of IBM) is about 19%, although Red Hat remains a lot smaller, generating revenues of about $5.6 billion in its last fiscal year, according to Light Reading's estimates. Neither company looks good next to the public cloud. AWS, for instance, reported sales growth of 37% last year, to a monstrous $62.2 billion.

Nor does VMware look very profitable alongside Broadcom. In its last fiscal year, it recorded an operating margin of about 19%, and its net income fell 12%, to $1.8 billion. With about $27.5 billion in sales during the year to October 2021 (a 15% year-on-year increase), Broadcom managed an operating margin of 31%, while its net income soared 128%, to more than $6.7 billion.

A growing appetite for open source code might also hinder VMware. It is certainly not opposed to the concept – VMware is, for instance, a major contributor to the Kubernetes open source project – but it lacks Red Hat's zealotry and still derives a quarter of its revenues from licensing software. In filings with the Securities and Exchange Commission, it acknowledges the open-source risks, pointing out that "the adoption of public cloud, micro-services, containers and open-source technologies has the potential to erode our profitability."

VMware's share price has been on a downward slide for the past year, losing about 40% of its value over that period. It had soared 22% in pre-market trading on May 23 after news broke of Broadcom's rumored interest. But the earlier dwindling valuation is a concern for some analysts. "Is everything going to public cloud leaving VMware with a steadily declining market opportunity?" wrote James Crawshaw, a principal analyst with Omdia, in a LinkedIn post. "That's what its share price and Broadcom's interest seems to suggest."

Related posts:

— Iain Morris, International Editor, Light Reading