Quick Thoughts: Bankers Rejoice in TMT Land

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai

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November 9, 2017

Quick Thoughts: Bankers Rejoice in TMT Land

  • S walks away from TMUS – Big potential synergies but Masa Son insists on control. Jump in capex inevitable, pressure on all carriers. More shoes to drop as telecom paradigm shifts.
  • DIS walks away from FOX – Linear TV deteriorating quickly. Critical scale and brand/franchise power vital vs. NFLX. Consolidation at the right price would be smart, but can’t avoid pain.
  • GOOGL and CRM cut a big deal for cloud services, hosting – VERY strong synergies could solve major problems for both partners; possible harbinger of something bigger?
  • AVGO hostile offer for QCOM – Roils the waters for NXPI deal and complicates AAPL negotiations. Could put other big chip names in play, XLNX, MediaTek, Infineon, even NVDA.

Back in September, we published a note outlining our view of how the next ten years of the TMT sector might play out. You can read it here (http://www.ssrllc.com/publication/the-cloudai-era-a-perspective-on-the-next-decade-of-tmt-investing-2/). Within our broader theses – Cloud/AI platform domination and ecosystem formation – we predicted a rash of consolidation, specifically calling out semiconductors and SaaS software as fertile soil for deal making. Acquisition chatter has risen to a roar over the past few weeks, as several mega-deals have been proposed and explored. Here’s our take on four of the biggest:

Sprint and T-Mobile – It’s been three years of flirting for these two. The bottom two carriers in a four-player wireless field could generate a TON of synergy if they got together – build one 5G network not two, exploit a mountain of wireless spectrum to drive superior performance and new services, cut all manner of expenses, direct all their competitive fire on the Verizon/AT&T duopoly. Should be worth tens of billions of dollars, more than enough to find a price that both companies could like. Why did it fall apart? Apparently, Softbank chairman Masayoshi Son has a secret plan for world domination that requires he retain control of the combined entity. Deutsche Telekom, the primary owner of T-Mobile USA, recognizing that its part of the proposed marriage was bigger, much faster growing, and much, much more profitable than Sprint, wasn’t prepared to step aside for Son. The next day, Sprint CEO Claure tweeted his happiness in going it alone, confirming that the company would dramatically step up its capital investment for rolling out 5G. That this came literally weeks after Claure’s assertion that Sprint could realistically hold down capex because it no longer had to support as many network standards. We were not surprised (http://www.ssrllc.com/publication/5g-rising-global-carrier-competition-to-drive-capex/)

Chairman Son floated his willingness to reopen talks for a fourth time if Deutsche Telekom had a change of heart, but I wouldn’t hold my breath. Meanwhile, T-Mobile will continue on its merry, disruptive path – it has momentum, cashflow, spectrum and a winning strategy – and Sprint will look around for a new dance partner, one that doesn’t want to lead. Perhaps a cable company? Sprint dallied in the arms of Charter during the last “off again” phase in its dysfunctional relationship with T-Mobile. Maybe two cable companies? Charter and Comcast have since struck a deal to stick together on wireless. Possibly Dish Networks, although Charlie Ergen has spectrum (which Sprint doesn’t really need) but not cash (which Sprint needs urgently). Would a tech giant like Google or Amazon ride to the rescue? Only if Masa Son’s vision is completely aligned with that partner’s agenda (it probably isn’t).

Disney and Fox – Somewhat after the fact, CNBC reported that Disney had had discussions with Fox about buying that company’s entertainment assets – studios, and non-news or sports networks. This prospect had some analysts calling it a “Netflix Killer” as part of Disney’s plan to take its iconic entertainment brand directly to consumers with a proprietary streaming service. The titillation is still a bit fantastic, as one of the two parties walked away from the table without a deal. There would be, of course, a lot of synergy in such a combination. Disney’s list of tentpole franchises would need another tent to hold them all, with the Marvel reunion the most intriguing addition. It also seems obvious that Disney is simply better at operating its studio than Fox has been with its own – that’s a benefit right away. It also softens some of the competition at the theater box office. Adding a stronger flow of content under Disney’s control also raises the odds on a successful transition to a proprietary streaming service, although the moniker “Netflix Killer” is pure hyperbole – the streaming leader has a pretty big head start with global subscribers and strong content strategy. No doubt the fall of PayTV will leave family budget to add a second and third streaming supplier in addition to Netflix, but I wouldn’t count on Disney’s future streaming platform – whenever they get around to launching it – to seriously hurt Netflix momentum. Meanwhile, Disney will have to cope with the accelerating erosion of its PayTV networks, led by ESPN. It will get worse before it gets better.

Google and Salesforce – Just ahead of this year’s Dreamforce, Salesforce’s annual confab for its best customers, CEO Marc Benioff announced a major partnership with Google, naming it a preferred partner for cloud services and unveiling integrations between Salesforce applications and Google’s Gmail, GSuite and Analytics products. Of course, 18 months ago, Benioff announced a similar partnership with Amazon’s AWS, naming it a “preferred cloud partner”, while in 2015, Microsoft CEO Satya Nadella appeared on the Dreamforce stage to talk about his company’s integration with Salesforce. It seems that Salesforce is a bit promiscuous when it comes to cloud partnerships.

Still, there may be a purpose in Salesforce’s serial dating. SaaS software is a bundled product – the customer buys both the application software AND the datacenter infrastructure on which it runs. We believe that Salesforce has a long-term problem – its own datacenter platform is subscale and less than state-of-the-art compared to the big three. Thus far, the strength of Salesforce’s applications outshines its infrastructure weakness, but Benioff knows that he will have to deal with it sooner or later. Of the main public cloud infrastructure platforms – Amazon, Microsoft, Google and, maybe, IBM – Google is by far the best fit. Amazon is a bit of a cultural mismatch – the flamboyant Benioff would likely chafe under the spartan leadership of Jeff Bezos. Microsoft has a LOT of overlap – meaning conflict as a partner and intense scrutiny in an acquisition – plus it has a young, successful CEO and no obvious place for Benioff to shine. IBM, well, IBM is IBM and an odd fit for Silicon Valley firm with Salesforce’s swagger.

Google and Salesforce are like chocolate and peanut butter. Google has an awesome hyperscale infrastructure but is having trouble selling it. Salesforce has an awesome salesforce, but needs a leading-edge platform. Google has excellent productivity tools, analytics software, and world best AI capabilities. Salesforce lacks productivity software and wants to improve its analytics and AI capabilities. Google needs value added application software to bundle with its infrastructure to lock in hosting customers. Salesforce is the second biggest SaaS application provider in the world (after Microsoft). CEO and founder Benioff has a friendly board and would look to hook-up with a company that could give him a kingdom to rule. The head of Google’s enterprise, VMWare founder and Silicon Valley legend Diane Greene, is 62 years old and would likely step aside in the event of a Salesforce acquisition. Synergies abound, both companies are Silicon Valley based, and the cultures are compatible. Right now, it starts with a broad partnership – Salesforce integrates G Suite and Google Analytics to its products, moves some of its products onto the Google cloud, and has its salesforce cross sell Google Cloud Platform services – but who knows how much further it could lead.

Broadcom and Qualcomm – We’ve already published our take on the Broadcom hostile play for Qualcomm (http://www.ssrllc.com/publication/quick-thoughts-broadcom-offer-is-another-twist-in-the-qualcomm-soap-opera/). To summarize, we are doubtful a deal gets done unless the offer price goes much higher. Meanwhile, the unwanted attention may push Qualcomm to move more aggressively to close its own deal for NXP and raise the stakes for Broadcom. Along the way, deal scrutiny may shine a brighter light on Broadcom’s earnings quality – years of acquiring and aggressive M&A accounting have GAAP earnings and free cash flows far below pro forma results. There is also something of a mismatch between Qualcomm’s long-term R&D focused culture and Broadcom’s cost cutting ethos. Nonetheless, the combination would be a formidable competitor in communications and automotive, with a strong play toward hyperscale datacenters as well. The sheer audacity of this Broadcom offer makes us wonder if other large cap semiconductor players could be put in play.

For example, Nvidia – Intel would certainly like to own it and it would complete the picture of a combined Broadcom/Qualcomm juggernaut, if either could stomach the price. Failing at Qualcomm could also see Broadcom turn to Infineon in a move somewhat parallel to Qualcomm’s NXP deal or to Taiwan’s MediaTek to take the object of its spurned advances on directly. Xilinx would be an interesting pick up for anyone not named Intel. Qualcomm or Intel could look at Broadcom radio rivals such as Skyworks or Qorvo. Smaller companies like Cypress, Maxim, Marvell, Cavium, and others have been suggested as M&A fodder – any of them could be bought. With the internet of things and wearables finally coming into play, sensor vendors, like Knowles or Invensense, could have appeal. With Broadcom apparently hell-bent on growth through acquisition, with Intel perhaps eager to lever its recent strength, and with Chinese chip makers anxious to gain global presence, the deal market would seem to be open.

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