PacCrest: Broadcom A 'Strategic Fit' For Avago

In a report published Thursday, Pacific Crest Securities analyst John Vinh said that Broadcom Corporation BRCM should be a strategic fit for Avago Technologies Ltd AVGO.

According to The Wall Street Journal, Avago is in advanced talks to acquire Broadcom. Although this news is not confirmed, Vinh believes that such an acquisition makes "strategic sense" for Avago, assuming it divests Broadcom's connectivity business.

In the report Pacific Crest Securities noted the reasons for being positive on the potential deal as:

• It would be immediately accretive to Avago's EPS and allow the company to sustain outsized earnings growth
• It would allow Avago to continue to diversify away from mobile wireless by acquiring Broacom's networking business, which would boost investor confidence in longer-term sustainable growth.

"We estimate fair takeout valuation for Broadcom at $60 per share, or 4.2x EV/sales, which is a slight premium over the group average of 4.0x. At $60, we estimate Broadcom would add $1.56 to our C2016 EPS estimate of $8.93 for Avago," Vinh commented, while adding that the deal "makes sense up to $65."

Vinh assumes that Avago will divest Broadcom's connectivity business in time, which generates operating margin of 12 percent. The proceeds from the divestiture, of $4.9 billion, would be used to repurchase stock. "In terms of financing, we estimate that the acquisition of Broadcom would be done through a combination of stock and debt financing," the report added.

While Qualcomm Inc QCOM could place a competitive bid, "we see less of a strategic fit for Qualcomm given (1) Its limited exposure in enterprise networking, and (2) redundancy in with Broadcom in mobile wireless connectivity," Vinh mentioned.

Pacific Crest Securities has an Overweight rating on Avago and a price target of $135; and a Sector Weight rating on Broadcom.