Last week, Broadcom shocked the market with their $105B offer to acquire Qualcomm, one of the largest mobile chip makers in the world and arguably one of the most innovative. While this deal is complex and unlikely to happen, it is not impossible, as CEO Hok Tan has shown a propensity to make large and complex deals like this happen. However, this deal is one that the street, customers, and more importantly the consumer should look at as anything but a winner.
In 2015, when Avago acquired Broadcom, it immediately went on to shed the company’s Internet of Things business unit to Cypress Semiconductor. This decision was a relatively easy one for Avago, which eventually decided to operate as Broadcom. The easy decision is because the strategy that Avago always had for growth was to acquire companies based on the opportunity to create almost immediate shareholder value. To do this with the $37B Broadcom acquisition, Avago needed to shed portions of the business that weren’t immediately performing financially. I also heard from my datacenter OEM contacts that Broadcom doubled the price of key components that it would take years for an HPE, Dell EMC, or Lenovo to design out. Nothing wrong with making money, but if your customers end up hating you and immediately set out to design you out, this is a recipe for long-term disaster.
Broadcom offers WiFi and Bluetooth but is primarily known now for their products that support the Data Center. Their primary focus is supplying technology to data center giants like Cisco, Juniper, Dell, and HPE. They certainly have a global reach but have been heavily invested in growth here in the United States as this is still the #1 data center market. This could be part of the reason for their decision to relocate their main headquarters back to the United States; this and of course the potential advantage it would give them in achieving regulatory approval for this 100+ billion-dollar deal as well as making it easier to acquire Brocade.
Furthermore, Broadcom operates as much more of a short-term focused company looking to leverage M&A and short-term R&D to achieve fiscal returns on a quarterly basis. Their R&D strategy tends to focus on low-risk markets where they can be competitive almost instantly on price and demand. This is a sound strategy that allows the company stock to perform well, but it arrives in great contrast to the approach of Qualcomm. There’s nothing inherently wrong
with wanting to make a fast buck, but if companies do not invest in the future, it is a slow path to nothingness, particularly in tech.
Qualcomm is primarily known for their technologies that enable smart phone connectivity. Their focus areas are in connectivity, advanced computing, and systems. They make money from the sale of their chips, but also have a vibrant, albeit less right now amidst their Apple dispute, licensing business where their technologies are found as critical in the development of almost every smart phone on the planet (you cannot find a smart device anywhere today that isn’t using the inventions of Qualcomm).
Unlike Broadcom, Qualcomm approaches their value creation through a much longer-term lens. This is an unpopular approach on Wall Street, but one that is critical to the innovation ecosystem. Qualcomm has developed its wealth and market position through taking longer-term bets on developing next-generation technologies like 3G, 4G LTE, and 5G. Often Qualcomm is working on their inventions and the growth of their patent portfolio for seven to ten years before those investments yield a return. This long view is what has brought us many modern capabilities that we enjoy in our mobile devices today, but we would likely be years behind if Qualcomm only focused on the technologies that could yield them return in just a few quarters. Qualcomm makes margins far above those of most of its competitors and certainly those of Broadcom, but that is because they have made large long-term bets that have given them a significant market advantage. The two companies are opposed when it comes to their growth strategies and R&D strategies. This becomes a loser for the greater market and would likely make a deal like this one disastrous long term.
It is not hard to make some predictions as to what Tan would do if such an acquisition were to come off. Much like Silicon Valley ax man of yesteryear Mark Hurd, Tan would look to create immediate shareholder value for the market by leaning down the Qualcomm organization and focusing on maximizing the current patent portfolio and chip business. While this would yield some short-term gains for shareholders, it would essentially cost important jobs within Qualcomm that have been responsible for setting the pace of innovation in the mobile market.
With 5G on the horizon, it is likely the immediate focus would go to extracting profits from this soon to arrive technology, however, Qualcomm has built its legacy on developing what is next, so if Tan continues his short-term approach to creating returns the massive investment that the Qualcomm of today would make in identifying and developing the next big thing in wireless and mobile would be stifled. Without trying to sound dramatic, I believe such setbacks would likely slow the growth of exciting new markets like Smart Cities, Artificial Intelligence and Autonomous Vehicles, Industrial IoT and even the potential of Edge Compute in a world of 5G and beyond.
Additionally, if Broadcom were to succeed in acquiring Qualcomm, and they did stick to their traditional value creation model it could create a weaker innovation in the United States putting global companies like Huawei in a much stronger position as they would be the likely candidates to step up and attempt to assume the vacancy left by a Qualcomm limiting their R&D efforts. This would just be one more black eye for the United States as Qualcomm has long made the US a leader in this space. Liken it to the downfall of mobile giants Nokia and Ericson leaving the EU with little to hang their hat on in the wireless space. Furthermore, if Qualcomm cannot continue their “system” approach to helping companies create competitive smart devices it puts greater power into the hands of a select group of smart device manufacturers whom would be able to even further push up prices while likely seeing better economics themselves.
For Qualcomm, the NXP acquisition makes much more sense. These two companies are complimentary and their approach to creating shareholder value is much more similar. As Qualcomm is not only upping its bets on mobile and wireless, but also on Industrial IoT, NXP has a similarly long view and R&D reuse rate. These factors contribute to not only creating long-term value for shareholders but also for society as a whole.
In short, the move by Hok Tan and Broadcom to acquire Qualcomm is admirable. The IP assets of Qualcomm company are tremendous, and the size of the combined company would make it a force in the semiconductor space. Hok sees what Wall Street does not, but that is not a surprise to me. Having said that, I believe these companies do not belong together. The long-term impacts that such a deal would have on the continued innovation in the mobile and wireless space is potentially damaging to both consumers who have enjoyed the inventions of Qualcomm in their daily use of smart phones as well as to the broader mobile ecosystem that has depended on Qualcomm to continue the advance of wireless for mobile and industrial use.
Yes, it is easy to see that there may be some short-term benefit for the largest shareholders of these companies, and perhaps some improved economics for current device makers, but surely those savings would not be passed on to consumers buying premium smart phone devices. If you have any doubt, just look at the economics of the iPhone X where consumers are paying more than $1,000 for a device that has margins said to be over 50%. It is safe to say those margins would only go to those companies, and there is no fault in that, but it certainly doesn’t help anyone but the select few.
Broadcom and its leader Hok Tan are as smart as they come at driving short-term returns on M&A activity. However, their first moves of cutting, slicing and disposing of anything that gets in the way of short-term profit will have devastating long-term effects on the entire mobile space. This deal is a loser for the main street, and even if a few folks on Wall Street win in the short term, we all lose in the long run.