The Ratings Game: Broadcom stock broadsided with worst day ever as CA bid met with confusion

Broadcom Inc. stock was on track for its worst one-day performance ever Thursday, as investors and analysts appeared confused about a self-proclaimed leading infrastructure-technology company agreeing to pay a premium for a legacy mainframe software company.

That confusion took the form of Broadcom AVGO, -14.20%  stock falling more than 15%, hitting an intraday low of $197.46. Until now, the stock’s worst day was on Oct. 10, 2014, when shares finished down 11.5%. More than 34 million shares changed hands by 2 p.m. Eastern, compared with the stock’s 52-week average daily volume of 3.3 million.

Late Wednesday, Broadcom said it was offering $18.9 billion for CA Inc. CA, +18.31%  , confirming earlier reports. The offer is Broadcom’s first major acquisition offer since the chip maker’s blocked acquisition of Qualcomm Inc. QCOM, +1.40%  earlier in the year. Ironically, about $16 billion has been shaved from Broadcom’s market cap in Thursday trading.

Don’t miss: Broadcom deal to buy CA makes little sense on the surface

Following the announcement, seven analysts cut their price targets on Broadcom, with three of those same analysts downgrading the stock to a hold rating, according to FactSet data. In contrast, two analysts raised their price targets, and one upgraded the stock to buy. All told, of the 38 analysts who cover Broadcom, 33 have overweight or buy ratings and five have hold ratings on the stock with an average price target of $305.57.

Instinet analyst Romit Shah, in a note entitled “Do We Still Trust Hock?” appeared very critical of Broadcom, suggesting the deal called into question the credibility of management, while recognizing the “impeccable track record” of Chief Executive Hock Tan.

“CA is a legacy software company that specializes in mainframes — shared synergies are not obvious,” Shah said. “More important is that this deal runs completely against the investment narrative that management has been articulating since their attempt to buy Qualcomm.”

Shah has a neutral rating on Broadcom, and lowered his price target to $225 from $250.

Don’t miss: How Broadcom vs. Qualcomm went from hostile takeover bid to a Trump blockade

In a note entitled “What The Hock?” Evercore ISI analyst C.J. Muse downgraded Broadcom to “in line” and lowered his price target to $275. Muse said Broadcom’s bid for the mainframe software company “seems more financial engineering/PE driven than due to any strategic rationale.”

“With software mainframe revenues in decline and no clear synergies to Broadcom’s current revenue streams, we struggle to understand Broadcom’s incentive here,” Muse said.

MKM analyst Ruben Roy, who has a buy rating and a $300 price target, was similarly nonplused by the deal.

“While Broadcom’s execution history on M&A could be viewed as a strong indicator of management’s ability to integrate acquisitions and meet longer-term financial targets, we are struggling to understand the rationale behind adding a low-growth software asset to the company’s strong portfolio of semiconductor technologies,” Roy said.

In a note, Morningstar analyst Abhinav Davuluri, who has a $300 fair value on the stock, called the bid a “typical Broadcom deal, including: a modest premium (20% over closing price on July 11); high profitability (85.8% gross margins last year), while adding to Broadcom’s treasure trove of market-leading franchises.”

See: Chip stocks log first losing quarter in nearly three years

However, Davuluri said the deal faces headwinds since “the firm faces secular growth headwinds in the mainframe market, due to the legacy nature of the platform,” and that the deal will be financed mostly through newly acquired debt. Also, it calls into question Broadcom’s intentions, announced in April, to buy back $12 billion in stock, he said.

Jefferies analyst Mark Lipacis, however, said he received assurances from Broadcom Chief Financial Officer Thomas Krause that the company remains committed to returning 50% of free-cash flow to shareholders in the form of a dividend, but Krause would only confirm that the $12 billion buyback authorization was still in place when asked about buybacks. Lipacis has a buy rating and a price target of $278 on the stock.

On the other hand, shares of CA rallied 18% to $43.93, after hitting an intraday high of $44, putting the stock on track for its best one-day percentage gain in more than 10 years, since shares gained nearly 20% on Feb. 1, 2008, according to FactSet. Thursday’s gain adds about $2.8 billion to CA’s market cap.

Three analysts raised their price targets on CA following the announcement for an average price target of $38.60. Of the 15 analysts who cover CA, two have buy ratings, 12 have hold ratings, and one has a sell rating, according to FactSet.

Shares of Broadcom are down 20% for the year, while CA shares are up 32%. In comparison, the S&P 500 index SPX, +0.72%  is up 4.5%, the tech-heavy Nasdaq Composite Index COMP, +1.22%  is up 13%, and the PHLX Semiconductor Index SOX, +0.36%  is up 6.9%.

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