On Broadcom Trying to Buy Qualcomm
If you want to watch the video first:
The way I see it, most of the voices I saw on this particular deal missed on the crucial issue. And that was the point I tried to make most of all in this video: It was not about Singapore. It was about the slashing-and-cutting of R&D and headcount that is so prevalent in this particular style of private equity.
In many of the Chinese companies that I have covered and will cover in the channel and newsletter, I keep noticing the focus on R&D spend (Hikvision, Huawei, HiSilicon, CATL, Carl Zeiss, etc). Not to say that rampant, uncontrolled R&D spend is good either (not all R&D is the same), but reducing it and reducing the speed and cadence with which you can bring out new products feels like a good way to fall behind in the market.
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It would have been the biggest technology deal in corporate history. In 2017, then-Singaporean semiconductor firm Broadcom offered $103 billion to buy San Diego-based chip maker Qualcomm.
The takeover became hostile and Qualcomm appealed to the government to review the deal. In an unusual move, the Committee on Foreign Investment in the US (CFIUS) took them up on that offer and then Trump blocked the deal on rather unusual national security grounds.
This failed hostile takeover soon faded into the background as the Trump administration moved on to other news-making things. A lot of them. Like the TikTok fiasco for example. But even at the time, I thought the whole kerfuffle was super interesting and worth a video. So thus it is.
Introduction to Qualcomm
Qualcomm is a semiconductor and telecommunications company that develops products for the wireless market. Founded in 1985, it went public in 1991 on the NASDAQ stock exchange.
The company established itself for its early research into wireless cell phone standards such as CDMA. Standards like CDMA are best described as ways to transmit and receive data streams over radio waves.
After some controversy, CDMA was brought into the 3G standard. 2G, 3G, 5G and so on - these are just general labels for referring to generations of mobile telecommunications technology. Technologies are adopted by various telecoms around the world.
CDMA being accepted as a 3G standard made Qualcomm's patents extremely valuable. The company has since been involved in the 4G and 5G standards. Its business model is to spend a whole lot on R&D to develop commercial wireless technologies and license those out to suppliers and operators.
Introduction to Broadcom
The company known as Broadcom is a weird beast. We should trace back to a Singaporean company known as Avago Technologies. Avago was spun off from the chip division of Agilent Technologies, which in turn was spun off from Hewlett-Packard.
Private equity firms KKR and Silver Lake teamed up with Singaporean state investors Temasek and GIC to found Avago Technologies. They levered up a $1.3 billion investment to pony up the $2.7 billion to purchase the company. When the company went public in 2009, the investor group made a handsome sum of money.
Knowing about Avago's private equity background helps you better understand their style of business. The company is known for its frequent acquisitions and takeovers. Once they have acquired the company, they radically cut expenses including R&D and focus on financially maximizing their big "franchises".
They did this for a variety of companies, including the $37 billion 2015 acquisition of the venerable Broadcom Corporation. When Avago took over Broadcom, they took the name as well. Now they were aiming for Qualcomm.
In November 6, 2017, Broadcom made a $103 billion offer to buy Qualcomm. This offer was almost immediately rejected by the Qualcomm board as being way too low. The takeover attempt soon became hostile and Broadcom began to reach out to Qualcomm shareholders so that it would be able to switch out the board's members.
That was when Qualcomm reached out to CFIUS.
What is CFIUS?
CFIUS stands for the Committee on Foreign Investment in the United States. It is an interagency committee headed by the Secretary of the Treasury that also includes the Secretary of Defense, State, and others.
They review foreign transactions and investment for whether or not the acquisition can stand to be a potential threat to natural security. For example, if the foreign investment could result in foreign control of a US company that makes military hardware.
Broadcom is a Singaporean company. If you recall, its predecessor Avago had Temasek and GIC as substantial foundation investors. Being in Singapore allowed it to better evade certain corporate taxes, yes, but it also maintains a large workforce there. So it was not the same as those Cayman Island shell companies in China.
But in November 2, 2017 - 4 days before the Qualcomm offer - the company announced that it was re-domiciling itself to Delaware. Broadcom CEO Hock Tan and Trump had a big press conference announcing it.
Both parties did the conference ostensibly to promote the President's big tax reform proposal. But it is also likely that the re-location had something to do with an acquisition in progress - storage networking company, Brocade - that was being held up due to CFIUS review. Broadcom believed that by moving to the United States, it could avoid that review. It also believed it would let them avoid CFIUS review of Qualcomm as well.
Review, Response and End
Qualcomm was already doing the standard anti-takeover procedures but in January 2018, it also filed a notice with CFIUS. Urged by politicians from both parties, CFIUS quickly announced that it would review the Broadcom and Qualcomm proxy battle. The board election would be postponed by 30 days.
CFIUS sent over a letter to Broadcom expressing its concern about the situation. The letter took into consideration Broadcom's private equity style and said that applying to Qualcomm would threaten the company's leadership position in telecommunications standards.
And if Qualcomm were to lose its leadership placement then Chinese companies like Huawei and ZTE would fill the void. Such a situation would have negative consequences on American national security.
They also noted their concern about the debt load incurred on the combined company and how it would force management to focus extensively on short term profit. Very astute.
In its immediate response, Broadcom did not address the substantive arguments of the CFIUS letter. Rather, it made an angry, emotional outburst. They wrote:
This was a blatant, desperate act by Qualcomm to entrench its incumbent board of directors and prevent its own stockholders from voting for Broadcom's independent director nominees.
They mentioned the fact that Broadcom was in the midst of moving from Singapore to the United States. They added:
Upon completion of the redomiciliation, Broadcom's proposed acquisition of Qualcomm will not be a CFIUS covered transaction.
Of course they probably should say that, because I get the sense that CFIUS hit the nail on the head. Broadcom has to gut Qualcomm and its R&D-driven business model in order to turn a profit and make the acquisition work. It is literally how they had operated up to this point.
In March 2019, Broadcom posted a letter to Congress that said, among other things, it would not sell any sensitive assets to foreign buyers and support the development of 5G technology in the United States. They would invest $3 billion in R&D and $6 billion in manufacturing out of the US.
Of course other companies, like AT&T, have made similar-ish pledges before and gone back on them. Who is going to actually try to unwind the acquisition years after it is consummated? Furthermore, their letter proves the math: Qualcomm alone spent $6 billion in R&D in FY 2020 alone. To do $3 billion in R&D across a combined Broadcom-Qualcomm entity is a pretty clear statement of intent.
The Broadcom people met with the Trump administration in a last ditch effort to save the deal. There, CEO Tan (who I believe became a US citizen in 1993 but I cannot be sure) explained that he held top security clearance and had been CEO for a company that made US military hardware components. In other words, a bona fide American patriot.
I do think Broadcom was right when it argued that once it became an American company, CFIUS would have no jurisdiction over the transaction. That might have needed testing in court, though. But Trump made the question irrelevant. Before CFIUS could issue a decision, Trump issued an executive order on March 12, 2018 blocking the deal.
Broadcom withdrew. Qualcomm reshuffled their independent board members and is today a $165 billion company. Broadcom for its part completed its re-domicile and eventually purchased an IT software company called CA Technologies. CFIUS did not get involved with that deal. It is today a $193 billion company.
Broadcom's style of operating reminds me of another private equity story: 3G Capital. 3G is a very famous private equity group that owns some of the biggest consumer brand companies in the world.
They own and run Anheuser-Busch InBev, the biggest beer company in the world. Restaurant Brands International, which owns Burger King, Tim Hortons and Popeyes. And Kraft Heinz, maker of that Mac and Cheese and ketchup. Warren Buffett has been a big backer of theirs.
They hand out this book called "How to Double Your Profits in 6 Months or Less". It's their internal bible. They ruthlessly cost cut with something called zero based budgeting, a budgeting style in which all expenses need to be justified for each new period. Where before you roll over the next year and modify as needed, with ZBB each year you restart from scratch.
3G's business style is to first buy a fat, stagnant consumer company, invest money in what it believes are its best parts, and fire or sell off everything else. This style is lean and mean and it gets financial results. When 3G bought out Heinz in 2013, it managed to raise its margins from the mid-teens to an amazing 28%. That's astounding for a big company in a mature space. They also fired a lot of people and closed a few factories, but that’s the deal.
Broadcom is 3G Capital's style adapted to the semiconductor business. Broadcom’s view is that, over the years, companies in the semiconductor space like Qualcomm have gotten to be large incumbents. Large, bloated and bureaucratic incumbents with lots of senior employees that are out of date, unmotivated and incompetent. They get big salaries and block the way upwards for the younger people, who soon leave. CEOs don’t want to fire these underperforming seniors so they put them in charge of underperforming divisions that just waste resources.
Broadcom comes in and fires them. They replace those top employees with younger people who might be able to do a better job. That's fine, they are more productive. But then again, what happens to the guy who lost a job? And the family they support?
Now in defense of private equity investors, I want to mention something. 3G is not just a vicious cost-cutting machine. Their overall goal is not only to get leaner, but to also invest in the best performing bits of the organization. Something that Tan from Broadcom calls "franchises". That means those younger people they brought in might even get paid more than the senior person who got fired. So they do not mind spending a lot on something they think is worth it.
Many people think that the Qualcomm block is about China. It might be, but I also get the sense that it is also about saving thousands of high paying jobs. CFIUS just happened to have the jurisdiction to get involved.
I guess I can leave you with this one last thing. 3G bought Heinz in 2013 and then merged with Kraft Foods in 2015. Margins soared like I said and things seemed peachy. They tried to buy Unilever but failed. And without that next big hit to cut the fat on, problems began to crop up a few years later. Consumer tastes had changed to favor healthier, organic products and the company did not have the right mix to appeal to them. The stock fell and the company struggled. It struggles to this day.
I do think that Broadcom is doing something interesting in the semiconductor and now corporate software space. It is going to change the way the industry works and it’s going to make a lot of people and investors rich. But I sometimes wonder if we are getting a bit too much capitalism here and need to think a little more strategically.
When Intel brought back Pat Gelsinger to be its CEO, people cheered because an "engineer" is in charge. Yet Broadcom is almost as valuable as Intel: $190B versus $240B despite less profit and being run by the financial engineers people don’t seem to like. So you can say that the market favors the Broadcom model over the Intel model ... and I think that's a problem in the industry's long run competitiveness.