VMWare May Be Doomed For Failure
For our first newsletter, we unwrap Broadcom's controversial VMWare Acquisition. Did they actually raise prices 12x?
If you’re a CEO of a well-established, multi-billion dollar company, the toughest question you’ll likely ask yourself is - what the bleep should I be doing to grow?? Imagine tomorrow you’re given reins of HP, IBM, or even LVMH for that matter - what would be your answer to this question?
The silver lining with many large companies today is that they have experience and scale which whittles their options down two one of two choices: either make big bets on your own team based on your core competencies and industry trends or just simply acquire a ton of companies. Execute M&A better than your competitors and be willing to invest large amounts of leadership, time, and money into each and every one of your acquisitions.
Several tech companies - Cisco, Microsoft, and IBM have become masters at this craft. Acquiring and flipping companies into cash-generating machines whose sole focus is increasing shareholder value. However, this fixation on shareholder value and stock price has shrouded this business model in much controversy. Salient today is Broadcom’s $69 billion acquisition of VMWare. Customers, employees and enthusiasts have all been strongly opinionated since the announcement. Let’s dive in!
Controversy Around “VMWare By Broadcom”
Why are so many people upset with this acquisition? We interviewed a current Chief Technologist of VMWare to better understand the aftermath of this acquisition.
It all boils down to the drastic change in VMWare’s revenue model post-acquisition. As he details, many VMWare’s customers actually have perpetual software licenses - you pay for the license upfront, and you have the right to use it indefinitely. Of course you’d also need support in case something doesn't work right? VMWare offered support services on a term license subject to renewal periods.
Here’s where it gets juicy. You see, after the acquisition happened, Broadcom quickly pushed to convert existing customers over to a subscription-based model. A consistent and reliable revenue stream that ensures a periodic revenue stream for Broadcom - makes a whole lotta sense right? As our insider shares, Broadcom more or less forced customers over to this new model with some shady practices. As soon as support periods ended, customers reported troubles with dependencies updating, VMs failing to boot up, and radio silence from VMWare support, of course.
If you were a customer, the fix is easy right? Just call up your designated VMWare sales rep and renew your support contract! Alas, it only gets nastier. “When customers try to renew their license, Broadcom calls it a renewal, but it’s actually a new license entirely” - as our source shares. Whenever a customer would be up for a renewal, they’d actually be forced into this new subscription model. In one extreme example, a customer who was up for a renewal on their $8 million contract was quoted $100 million for the new term! All of this was made possible by highly compensated and incentivized sales teams that stood to benefit from converting customers.
While extreme, the takeaway here is that Broadcom knew that they had VMWare customers by the balls and did not hesitate to take advantage of the situation. As our insider added, VMWare only has a few serious enterprise competitors, namely Microsoft. However, VMWare's reach and scale - as well as technical complexity - are just on another level. In their official post about the change, they announce how they are moving their full suite of products into two subscription options, labeling it a “dramatic simplification of their offerings”. Amazes me how companies spin their obviously unpopular decisions.
So, Broadcom obviously bought VMWare to profit off massive subscription revenue, but why did Dell sell a company worth more than itself?!
Why Dell was so eager to sell - an insider’s opinion
Simple answer here is Michael Dell. After taking Dell private in the early 2010s, Michael was trying to get Dell into the enterprise space and more specifically create a hyper-converged box (a single box with storage, compute, and networking). At this time VMWare, EMC, and VCE had already achieved this. Rather than pour R&D into this, Dell just bought them out!
Michael levered the company and himself up with tens of billions of debt to complete a $67 billion acquisition of EMC and VMWare. Between 2016 and 2017 Dell more than quadrupled its long-term debt from around $10 billion to more than $40 billion in just long-term debt. A sale of $69 billion meant $55 billion in proceeds for Dell (napkin math here). Having the opportunity to sell just VMWare for the price he paid for both EMC & VMWare was massive - an offer he simply couldn't refuse.
Patterns in the past
Unwrapping their past, Broadcom is known to wring companies dry, either by fundamentally changing their business model to fit Broadcom’s objectives or simply dismantling the company while keeping the profit centers. Quickly after Broadcom’s 2019 acquisition of CA Technologies, it moved to convert CA’s mainframe and software solutions business into a reliable subscription model - moving away from the perpetual license model they had.
This juice squeezing is a typical move by Broadcom. In 2019, Broadcom acquired the security giant Symantec - splitting the company in two. Broadcom scooped up Symantec’s enterprise security division and left the consumer business, NortonLifeLock, alone. Competitors to Symantec such as CrowdStrike and Palo Alto Networks have a combined market cap of more than $150 billion today, ~15x more than the $10.7 billion acquisition in 2019.
Broadcom’s grim reality
It’s mentioned in our video about Broadcom that they touch 99% of internet traffic through their network chips. This begs the question - what’s a chip & networking company doing buying virtualization software, enterprise security solutions, and other software?
Well, simply put, the chip-making industry is quite cyclical. Kinda crazy to think about today given chip shortages and record-high stock prices in semiconductor companies, but between 2005-2016, semiconductor revenue only grew 3.37%, compared to more than double since then. No wonder they’re obsessed with reliable and predictable subscription revenue!
See - when you reach a certain level of maturity as a non-FAANG company, you’re essentially this large, bloated company that’s sitting on a ton of cash. As a CEO, you can easily satisfy your shareholders by going on a spending spree every quarter or year. Compare this to the rather grim alternative Meta pursued with Reality Labs. Billions in R&D and investments into an in-house project. You’re stuck justifying this to shareholders that believe it's more of a fugazi than anything.
Broadcom, similar to Cisco, Constellation Software, LVMH, Disney, and others are nothing more than the modern day private equity firm. The combination of billions in the bank and a team of ex-Mckinsey Harvard MBAs are poised to drop the next hottest M&A on the street.
While it's hard to call this strategy real innovation or ingenuity, which is what should be expected of any company, even I’d be elated to acquire a company like VMWare. Get this: VMWare’s revenue was a mind-boggling $13 billion – ⅓ of Broadcom’s total revenue today! That $69 billion acquisition is not too shabby considering their current market cap is $570 billion.
“It’s business, it’s not personal” is what I imagine all Broadcom executives are out there saying about the VMWare acquisition. Similar to how they killed off Symantec and allowed other players to grow, it will be important to observe how direct competitors of VMWare will fare in this new competitive landscape. Will this acquisition enable cloud providers to thrive even more? Is VMWare ready for the age of AI-optimized servers?
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