The two companies have entered the definitive agreement for the acquisition, and it has been approved unanimously by both companies’ boards. The price which Broadcom agreed to pay NetLogic’s shareholders is $50 a share in cash, so the total valuation is around $3.7 billion, net of cash assumed. In addition, Broadcom assumes employee equity with value of around $450 million in total (15 million shares). The acquisition is expected to be closed in 1Q 2012 subject to the shareholder vote, regulatory clearance and other customary closing conditions.
In the presentation of Broadcom, there are three main strategic rationales for the acquisition with nearly 60% of premium over the market price. First, it would add the leading technology to enable the delivery of integrated end-to-end platforms for the customers. Second is to expand the market significantly, it is expected to more than double Broadcom market infrastructure to $12 billion, and to enter the embedded processors as well as create opportunities in wireless infrastructure business. Last is for the financial benefits with the growth in revenue, non-GAAP product gross margins and EPS.
According to the CEO of Broadcom Scott McGregor, NetLogic is a decent growth company; it would accelerate Broadcom’s revenue growth and increase the company’s market opportunity. Because Broadcom and NetLogic have nearly the same customers, but Broadcom chips help direct traffic across networks, whereas NetLogic chips are used to examine the type of data on the network for it to be more efficient. “It doesn’t bring us any new customers but it brings us new value for the customers we have”, McGregor has commented.
For the financial impact, it is expected that the acquisition would improve the revenue growth and non-GAAP product gross margin, and it would be accretive to non-GAAP EPS by $0.1 in 2012. Cody Acree, Williams Financial analyst, has expressed his opinion on the purchase price: “It's a high premium but it's a necessary premium. NetLogic has a huge amount potential; they've developed a portfolio of products that's unique and difficult for Broadcom to reproduce."
Looking back at the operation of NetLogic, for the last six years since 2004, the earnings of the company has been fluctuating very wildly, the mixtures of three years negative and three years positive net income. The majority of assets are in goodwill and intangible, which takes nearly 50% of the total assets. But it’s healthy capitalization. The company is quite debt light, no short or long term debt and the equity accounts for nearly 80% of the total assets.
The good point about NetLogic is the steady increase in cash flows, both operating cash flows and free cash flows. For the last five years from 2005 – 2010, its free cash flow has gone up from $24 million to $100 million, with annual compounded growth of 33%. The price that Broadcom would pay NetLogic would assume the valuation of 37x FCF 2010, which seems to be a very high price. If we do the discounted free cash flow analysis, using the conventional discount rate of minimum 10% of Benjamin Graham, the valuation of $3.7 billion would assume that NetLogic FCF growth of 25% per year over the next five years and then it would grow 1% to infinity. For the historical record of NetLogic free cash flows, that seems to be the reasonable price. Besides, taking into the great synergy between the two companies that would add a lot of value for the customers of both companies, I personally do not think Broadcom has made a poor decision.