Merger Mating Dance, And Who Gets The Rose Next. Broadcom Is A Player, Part II – Broadcom Inc. (NASDAQ:AVGO) No ratings yet.

2019 Was Good for Mergers; 2020 Will Be a Lot Better

2019 is the sixth best year in the last 20 for M&A. I can only reflect that to my mind the pace is accelerating, and that has been the inspiration for this set of articles. I expect that 2020 will accelerate even further, for the reasons that I listed in Friday’s article. There are macroeconomic forces pushing mergers as well as sector-specific reasons, and most importantly, there are stock market forces favoring the motion towards mergers. Macro-economically, global growth opportunities are not easily found. The easy answer was once moving into China, which hasn’t worked in the last two years and is still an open question.

America is the Best Place for Equities – Mergers or No

Also, and this is not about nationalism, in my opinion. The best opportunities are here in the good-ole USA. With low interest rates and low inflation, staying with the same strategy will not earn CEOs their keep. I have made the assertion that we are in the midst of a little-noted boom in small-town businesses, or at least small business that caters to the consumer. I believe that even tech innovation is bottom-up. Look at what is going on in the Biotech space. All the real innovation is in those tiny development companies. It’s the same in cloud-tech and every other space that is ripe for change, look at the payment space for example. The best way for the big-cap stock to grow is to buy some of that magic. If they don’t, they’ll end up like IBM (IBM), Oracle (ORCL), or in the case of Tesla (TSLA) disrupting the entire internal combustion engine-powered car biz – like General Motors (GM), or even BMW, and Mercedes Benz. Or Amazon (NASDAQ:AMZN) destroying all the department stores. So here is my perspective on some of the most likely merging areas.

Energy consolidation

Just to kick off the discussion on the Oil sector, we have news this weekend through Bloomberg that WPX Energy (WPX) is buying PE-backed Felix Energy for $2.5 Billion. Felix operates in the productive and oily Delaware Basin of the Permian. You’re probably thinking Felix is private equity. That isn’t a public company acquisition and doesn’t count. Look it’s too early to get details, but I bet WPX is offering shares in this deal as well perhaps as some cash. E&P companies are starved for cash. I doubt it will be much. The key is that this sector MUST be consolidated. There are too many players; too many started when oil was over $100 PBL. Too many that paid for land leases at the height of that bubble. The news that a Private Equity company is selling is the canary in the coal mine. It is a financial actor, and it probably bought acreage on the cheap from bankruptcy or from another E&P needing cash. I really can’t imagine that WPX would use any substantial debt to acquire this acreage, even if it could go to the debt markets. It needs any credit it can get for its own survival, and even if it is generating cash flow, it needs that to pay down its own debt that it most assuredly have.

Equity Can be the Coin of the Realm

No, the point I am making is that EnCap Investments is willing to take WPX equity. This means that equity-based mergers will break the log-jam, and perhaps at some point, cash will enter the mix as well and really accelerate M&A. Look, I have gotten burned in a major-league way in predicting the consolidation of the E&P sector. Perhaps I will be right in the end, but you also need to be right at timing in trading. Boy, was my timing off. In fact, I am not convinced that the time is right right now. Everyone hates the oil sector. The Millennials consider oil companies as bad as cigarettes, and they are the investors of the future. It doesn’t matter that we will still be pumping oil 200 years from now. Oil is tremendously valuable; too bad we burn it for fuel, but that is another discussion. The question is why would EnCap accept equity?

The cure for low prices is low prices

As much as the greenies hate oil, it is a necessary evil. Unfortunately for oil companies, the slump in prices from over $100 to at one point briefly under $40 per barrel hammered their profits. This resulted in underinvestment in conventional oil exploration. Domestically, the well-known shale-fracking boom went unabated, until now. Production from shale wells declines faster than traditional oil wells in general. On top of that, producers have in the last couple of years tried to eke out as much oil as possible to stem a fall in revenue amid weak crude prices. Production from the Permian Basin has been rising about a million barrels per year and was at 3.8 million barrels per day at the start of 2019. However, the base production is expected to decline by 40%, or about 1.5 million barrels of oil per day by the year-end according to IHS. The fall-off in production will pose an existential crisis for a lot of the small E&P companies. They can no longer go to the debt markets to finance their operations. The level of production will even out until and unless the bigger players start hoovering up the small-fry on the cheap. The WPX acquisition may finally be the herald of this long-delayed but a necessary rationalization.

My Take: What to do with this space? For now, watchful waiting on the E&P names. Better to buy the big boys, like a BP (BP) or a Chevron (CVX), or a Total (TOT), or maybe Occidental Petroleum (OXY). Look for big dividends to pay you while you wait. This is not a fast money situation unless you want to lose money fast. If you really want to invest in the little fish, go for the ETF XOP.

LNG

I said that I would have more ideas in reference to LNG. The truth is, the clock ran out. I do have one idea for the long-term investor. I think Dominion Energy (D) with its juicy 4.55% dividend could turn out to be a very good LNG opportunity. Dominion is one of the only LNG exporters on the east coast of the US, and as such, I think that it should be able to sell as much LNG as it can produce. If China is really going to commit to significant LNG imports from the US, it would make sense to build more trains as well. The reason why I think being on the east coast is an advantage is that LNG is now a global fungible commodity, so demand pull from China means more opportunity from Europe. Also, D can send LNG to Asia as well. My sense is that there is a sort of traffic jam on the Texas coast, and there is plenty of NatGas in Pennsylvania and the whole Marcellus region. There is plenty of room for more export terminals on the east coast. That said, there are plenty of opportunities for everyone if this new incremental demand turns out to be real.

I am very intrigued by this new level of demand from China and how it changes the complexion of the LNG space. It has been revealed that China was planning to build a huge number of coal-powered plants. I believe that with this commitment (again if it is real and significant), China is exposing new demand to LNG. I want to do some additional thinking in this area, and I suggest that if you are interested in investing in energy, you should as well. Yes, this is a bit of diversion from the theme of mergers. I have no idea if there are merger opportunities here, but I broached this topic in Part I, and promised more, and here we are.

Cloud Services Consolidation

I am using this designation to address services companies like a Salesforce (CRM), or an Adobe (ADBE), or a Workday (WDAY). These were once considered enterprise applications, for which big companies would pay a big license to operate the software in their data centers. The old kings of that space SAP and ORCL are fading. Moreover with the cloud, much smaller companies can avail themselves of computing. With the expansion of the market and the lowering of costs has come a huge volume of new tech application providers on the scene. Many are so specialized that they would do better as a subsidiary of a larger company. We have seen in the data presentation space. CRM just bought Tableau for instance, yet there are so many data management and presentation stocks out there – Cloudera (CLDR) (Carl Icahn already involved), Domo (NASDAQ:DOMO), Splunk (SPLK), Alteryx (AYX), Smartsheet (SMAR) are out there, and I am sure I missed some. I would even put the venerable Teradata (TDC), which is trying to move to the cloud/subscription model on this list. Perhaps PE would find TDC a good target. My point is I would not be shocked if there was further consolidation in this space.

There are a bunch of small cloud names that I question should be independent, names like Zuora (ZUO), or a Yext Inc. (YEXT), or as I cover in the IPO Corner, Bill.com (BILL) and Sprout (SPT).

Joe Terranova Id’d DocuSign (NASDAQ:DOCU) as a possible takeover candidate when he appeared on CNBC. I can see why he would make that leap. DOCU is growing rapidly in a space that has an effect on the bottom line. You can’t close a deal without a signed contract. In typical “land and expand,” DOCU is evolving services to include the “Agreement Cloud” a set of services that enhance collaboration leading to an agreement. They are well integrated within the Salesforce ecosystem. This also makes sense since CRM is about sales and customer management. So CRM is suspect number 1, I suggest another possible player and that would be Adobe. After all, ADBE is a frenemy of CRM, and I bet they would love to steal away DOCU if it was in fact for sale. The better reason is that ADBE is a major document management company providing Acrobat and PDFs. I do know that ADBE has moved on to many other sectors. I find this “Agreement Cloud” very interesting, and with good potential for future growth. Also how it would fit with Box Software (BOX) and Dropbox (DBX) both of which provide secure collaborative spaces for intercompany work. They are beating the heck out of each other. It seems to me that DOCU could buy one of them and leverage its customer base.

Nutanix (NTNX) – Here is a CRN (a Tech media outlet) quote by Michael Dell:

“Dell To Become ‘Six-Times’ Bigger Than Nutanix, Says Michael Dell. So we’re No. 1, and we’re more than twice the size of No. 2 [Nutanix]. We have our sights set on being three-times, four-times, five-times, six-times bigger than No. 2 (NTNX), regarding hyper-converged infrastructure market share.”

Hyperconverged Clouds: Their function is to bring cloud functionality into corporate data centers, giving the IT department the freedom to run some services in-house and over to the cloud as needed. Dell used to resell NTNX technology. Now it developed its own software at VMware (VMW). NTNX has now expanded to the multi-cloud, so it doesn’t totally rely on this space. The fact that a well-known star in technology feels like he has to call out tiny NTNX says a LOT.

NTNX collaborates with HPE for hybrid-cloud, also IBM, and Chinese tech companies. I could see HPE looking to acquire NTNX to get in on the growth. Though HPE would have to pay up, just like IBM did when it bought Red Hat. I think NTNX can stand alone, and I am a bull, but I think NTNX’s technology is very disruptive, and the only real challenger to VMW. Maybe an ORCL or an HPE does swoop in, and pay up for it.

My Take: It would be a mistake to invest or trade purely on the possibility that a name will be acquired. Look for great companies that have fast growth and a path to profits, or growing existing profits. At the right price, most of the names mentioned above will make good trades. Once the consolidation takes place in earnest, it will positively affect all the names in this space. I will do my best to surface good trades or speculations in 2020. Mark my words though, this space will be consolidated by the names that need growth. Another surprise might be that similar-sized stocks get together, like BOX to DBX, or DOCU. Or maybe a MongoDB (NASDAQ:MDB) looks to combine with a SPLK. ServiceNow (NOW) consolidates as an acquirer, with the new CEO Bill McDermott stating that he wants to get NOW to 10 Billion in revenue. The best way is to buy your way in. So who else are the consolidators? CRM, ADBE, Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) will try to consolidate cloud names for GC, Microsoft (MSFT) for Azure, ORCL will try, but I doubt its quarry will go willingly. IBM is too busy destroying Red Hat. Any acquirer will have to pay up, 40-50% above their pre-offer trading price. They still might have to pay up from there.

Chips

This space has been on hold due to the unwillingness of China to approve any mergers. The sign that this freeze is over is when Nvidia (NVDA) and Mellanox (MLNX) are allowed to combine. The big news is that Broadcom (AVGO) has made it known that it is willing to sell its huge wireless chip business. I think this is a sign that consolidation is about to be kicked off big time. The CEO of AVGO, Hock Tan, is remaking AVGO into a hybrid Private Equity and Tech company. Most if not all PE companies are financial actors; AVGO was an operator. I believe that Hock Tan is cashing in his chips as it were to jump into the enterprise software space. It bought Computer Associates (NASDAQ:CA), with very good results, and it apparently likes its new acquisition in the Symantec enterprise security business. That said, with 5G looming, and growth in IoT, like self-driving cars and industrial apps, chips are plenty chipper. I think Microchip Tech (MCHP), Lattice Semi (LSCC), Cirrus Logic, Inc. (CRUS), maybe Teradyne (TER) in the equipment space. Again with 5B maybe someone takes out a Skyworks (SWKS) or a Qorvo (QRVO), with Qualcomm (QCOM) as the buyer. I think QCOM will be an acquirer as it tried to buy NXP Semi (NXPI) only to be thwarted by China.

Analyst Corner

These two analyst blurbs were quoted from Barron’s A Vote for Peloton Interactive Stock:

Peloton (PTON): Heading into the holiday season and coming off our recent meetings with management, we take this opportunity to reiterate some of the key themes/opportunities for Peloton going forward-increasing consumer adoption/brand awareness against a large global addressable opportunity, hardware and subscriber growth with improving conversion (driven in part by Peloton’s new Home Trial initiative), momentum in international markets, and a path to profitability driven by leverage on fixed content and marketing costs on a growing subscriber base. While we make no changes to our forward estimates, we increasingly see the potential that management guidance/Street estimates may prove conservative for the holiday quarter and into calendar-year 2020. We reiterate our Buy rating and raise our price target to $40 from $30.

Home Depot (HD): We are upgrading Home Depot from Neutral to Outperform; While we are early, we believe that HD offers an attractive risk/reward now after its recent pullback (-11% since third-quarter results), and yesterday’s guidance reset, with optionality on improving external and internal drivers in fiscal year 2020. Beyond that, we firmly believe in this team and the initiatives aimed to expand its reach to new customer segments and categories, while leveraging its stores, building a differentiated omnichannel and digital experience, and creating the fastest delivery network that will widen its moat over time. Initial reads from these efforts seem positive.

My take: You know I like both names. PTON has 66% of its float short. If PTON bounces, it could create some alpha in short order (pun intended)

Netflix (NFLX) was downgraded by analysts at Needham & Company LLC from a “hold” rating to an “underperform” rating on Tuesday.

My Take: I put NFLX back on our buy list, as I expect it to fall to a lower support level. My attention will be focused once it falls below 286. I identified 320 as the top; my levels are 280/275 and then I expect 260ish to hold.

Insider Corner

Occidental Petroleum Director Jack B. Moore purchased 12,900 shares of the company’s stock in a transaction that occurred on Friday, December 6th. The shares were purchased at an average cost of $38.61 per share, with a total value of $498,069.00. Following the completion of the acquisition, the director now owns 129,203 shares in the company, valued at approximately $4,988,527.83.

My Take: OXY acquired Anadarko Petroleum last year. Apparently, OXY was early as well in the consolidation dance. In any case, OXY was treated harshly by market participants. I have to admit that I have not reported on insider buying activity with oil companies. There has been a lot lately. Frankly, I did not want to encourage speculation in this fraught sector.

IPO Corner

Sprout IPO is on Friday at $17 per share.

Will generate over $100 million in trailing GAAP revenue this year; it reached $100 million ARR mark between Q2 and Q3 of 2019.

Sprout Social grew by a little over 30% in the first three quarters of 2019. That’s a healthy rate, but other newly public companies can grow at 100%. Bill.com IPO’d just the day before is growing much faster and its debut was greeted with much more enthusiasm.

That doesn’t mean that SPT is anywhere near a value stock. Even at the level it debuted, it is trading at nearly 8 times revenue. SPT is an interesting business in that it helps companies manage all of their social media interactions with the public. I have to wonder why a Twitter (TWTR) or a Snapchat (SNAP) doesn’t offer some sort of white-glove service for super-users of Twitter. In any case, SPT has not been accepted by market participants so well. It actually broke its IPO price of $17. I would not recommend buying it now, but if it was cut down to 5 times revenue and if you are patient capital, then at 30% growth, that price could be justified.

I wrote about BILL last week. I like the company, but I think its price will come down to earth. I love the service personally, I think it’s great for small- and medium-sized businesses and is useful for large companies to manage their relationships with small contractors and suppliers. Since this is a merger oriented article, I have to state that I wonder if BILL should be a separate public company. Why isn’t Intuit (INTU) a better home for it? Or a PayPal (PYPL), or Square (SQ) or even a Paychex (PAYX). Also, I don’t know if BILL has a sufficient competitive moat to maintain the lofty price, or growth.

Trading Corner

So of all the companies I wrote about today, the one that I think is the most interesting is Broadcom. The moves that Hock Tan has made and is about to make will be the stuff of legend. He is creating a new kind of company, one that is sort of an old type of company – the old fashioned conglomerate. The kind of conglomerate that views its subsidiaries as if they were part of a portfolio. This has not really been attempted in this way before, which is a multi-line tech company that is built and rebuilt by acquisition and divestment. All the while, AVGO is paying a fantastic dividend. If bought right it can be a fast money trade, a speculation or a long-term investment. I suspect that if it really does auction off its wireless chip business, it will introduce volatility as traditional chip investors may sell out. If Hock Tan has really unlocked the ability to generate incremental profits out of a moribund business like CA, then there is a lot that he can do. I think AVGO is a buy for the long-term investor paying nearly 3 ¼% dividend. For the trader, let’s look at the chart…

Despite the fact that AVGO dropped more than 12 points, it is still in a strong uptrend. A real technician would buy either on a bounce from this level tomorrow or wait for a breakout. If you want to speculate, perhaps wait for a retreat to the horizontal line at the 290 level. It will be interesting to see what happens if Mr. Tan does confirm that he is going to auction off the Wireless division. If you really like this stock idea and just want to buy, after you do your own due diligence, start small. I suspect there will be some volatility coming in this name.

Disclosure: I am/we are long DOCU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long CALLs with DOCU. I am considering starting a long-term investment in AVGO.

Source link

Please rate this