 From theCUBE Studios in Palo Alto in Boston, bringing you data-driven insights from theCUBE and ETR. This is Breaking Analysis with Dave Vellante. In the words of my colleague, CTO David Nicholson, Broadcom buys old cars, not to restore them to their original luster and beauty. Nope, they buy classic cars to extract the platinum that's inside the catalytic converter and monetize that. Broadcom's planned $61 billion acquisition of VMware will mark yet another new era and chapter for the virtualization pioneer a mere seven months after finally getting spun out as an independent company by Dell. For VMware, this means a dramatically different operating model with financial performance and shareholder value creation as the dominant and perhaps the sole agenda item. For customers, it will mean a more focused portfolio, less aspirational vision pitches and most certainly higher prices. Hello and welcome to this week's Wikibon Cube Insights powered by ETR. In this Breaking Analysis, we'll share data, opinions and customer insights about this blockbuster deal and forecast the future of VMware, Broadcom and the broader ecosystem. Let's first look at the key deal points. It's been well covered in the press, but just for the record, $61 billion in a 50-50 cash and stock deal resulting in a blended price of $138 per share, which is a 44% premium to the unaffected price, i.e. prior to the news breaking. Broadcom will assume $8 billion of VMware debt and promises that the acquisition will be immediately accretive and will generate $8.5 billion in EBITDA by year three. That's more than $4 billion in EBITDA relative to VMware's current performance today. In a classic Broadcom M&A approach, the company promises to delever debt and maintain investment grade ratings. They will rebrand their software business as VMware, which will now comprise about 50% of revenues. There's a 40-day go shop, and importantly, Broadcom promises to continue to return 60% of its free cash flow to shareholders in the form of dividends and buybacks. Okay, with that out of the way, we're going to get to the money slide literally in a moment that Broadcom shared on its investor call. Broadcom has more than 20 business units. Its CEO, Hock Tan, makes it really easy for his business unit managers to understand. Rule number one, you agreed to an operating plan with targets for revenue, growth, EBITDA, et cetera. Hit your numbers consistently and we're good. You'll be very well compensated and life will be wonderful for you and your family. Miss the number and we're going to have a frank and uncomfortable bottom line discussion. You'll have four, perhaps five quarters to turn your business around. If you don't, we'll kill it or sell it if we can. Rule number two, refer to rule number one. Hello, VMware, here's the money slide. I'll interpret the bullet points on the left for clarity. Your fiscal year 2022 EBITDA was 4.7 billion. By year three, it will be 8.5 billion. And we Broadcom have four knobs to turn with you, VMware to help you get there. First knob, if it ain't recurring revenue with rubber stamp renewals, we're going to convert that revenue or kill it. Knob number two, we're going to focus R&D in the most profitable areas of the business, aka expect the R&D budget to be cut. Number three, we're going to spend less on sales and marketing by focusing on existing customers. We're not going to lose money today and try to make it up many years down the road. And number four, we run Broadcom with 1% G&A. You will too. Any questions? Good. Now, just to give you a little sense of how Broadcom runs its business and how well run a company it is, let's do a little simple comparison with this financial snapshot. All we're doing here is taking the most recent quarterly earnings reports from Broadcom and VMware, respectively. We take the quarterly revenue and multiply by 4x to get the revenue run rate. And then we calculate the ratios off of the most recent quarters revenue. It's worth spending some time on this to get a sense of how profitable the Broadcom business actually is and what the spreadsheet gurus at Broadcom are seeing with respect to the possibilities for VMware. So combined, we're talking about a $40 plus billion company. Broadcom is growing at more than 20% per year, whereas VMware's latest quarter showed a very disappointing 3% growth. Broadcom is mostly a hardware company, but its gross margin is in the high 70s. As a software company, of course, VMware has higher gross margins, but FYI, Broadcom's software business, the remains of Symantec and what they've purchased as CA has 90% gross margin. But the iPopper is operating margin. This is all non-gap, so it excludes things like stock-based compensation. But Broadcom had 61% operating margin last quarter. This is insanely off the charts compared to VMware's 25%. Oracle's non-gap operating margin is 47%, and Oracle is an incredibly profitable company, okay? Now, the red box is where the cuts are going to take place. Broadcom doesn't spend much on marketing, it doesn't have to, its SG&A is 3% of revenue versus 18% for VMware, and R&D spend is almost certainly going to get cut. The other iPopper is free cash flow as a percentage of revenue at 51% for Broadcom and 29% for VMware. 51%, that's incredible. And that, my dear friends, is why Broadcom, a company with just under $30 billion in revenue, has a market cap of 230 billion. Okay, let's dig into the VMware portfolio a bit more and identify the possible areas that will be placed under the microscope by Haktan and his managers. The data from ETR's latest survey shows the net score or spending momentum across VMware's portfolio in this chart. Net score essentially measures the net percent of customers that are spending more on a specific product or vendor. The yellow bar is the most recent survey and compares the April 22 survey data to April 21 and January of 22. Everything is down in the yellow from January, not surprising given the economic outlook and the change in spending patterns that we've reported. VMware cloud on AWS remains the product in the ETR survey with the most momentum. It's the only offering in the portfolio with spending momentum above the 40% line, a level that we consider highly elevated. Unified endpoint management looks more than respectable, but that business is a rock fight with Microsoft. VMware cloud is things like VMware cloud foundation, VCF and VMware's cross cloud offerings. NSX came from the NYSERA acquisition, Tanzu is not yet pervasive and one wonders if VMware is making any money there. Server is ESX and vSphere and is the bread and butter. That is where Broadcom is going to focus. It's going to look at vSAN and NSX, which is software probably profitable. And of course the other products and see if the investments are paying off. If they are, Broadcom will keep. If they are not, you can bet your socks. They will be sold off or killed. Carbon black is at the far right. VMware paid $2.1 billion for carbon black and it's the lowest performer on this list in terms of net score or spending momentum. That doesn't mean it's not profitable. It just doesn't have the momentum you'd like to see. So you can bet that is going to get scrutiny. Remember, VMware's growth has been under pressure for the last several years, so it's been buying companies, dozens of them bought AirWatch, bought Heptio, Carbon Black, Macera, Saltstack, Daytrium, Verstow, Bitnami, and on and on and on. Many of these were to pick up engineering teams. Some of them were to drive new revenue. Now this is definitely going to be scrutinized by Broadcom. So that helps explain why Michael Dell would sell VMware. And where does VMware go from here? It's got great core product. It's an iconic name. It's got an awesome ecosystem. Fantastic distribution channel, but its growth is slowing. It's got limited developer chops in a world that developers and cloud native is all the rage. It's got a far-flung R&D agenda going at war with a lot of different places. And it's increasingly fighting this multi-front war with cloud companies, companies like Cisco, IBM Red Hat, et cetera. VMware's kind of becoming a heavy lift. It's a perfect acquisition target for Broadcom and why the street loves this deal. Now, and we titled this breaking analysis, Taming the VMware Abyss, because VMware is a beast. It's ubiquitous. It's an epic software platform. EMC couldn't control it. Dell used it as a piggy bank, but really didn't change its operating model. Broadcom 100% will. Now, one of the things that we get excited about is the future of systems architectures. We published a breaking analysis about a year ago talking about AWS's secret weapon with Nitro and its Annapurna custom silicon efforts. Remember it acquired Annapurna for a measly $350 million. And we talked about how there's a new architecture and a new price performance curve emerging in the enterprise driven by AWS and being followed by Microsoft, Google, Alibaba, a trend toward custom silicon with the ARM-based Nitro, and which is AWS's hypervisor and NIC strategy, enabling process of diversity with things like Graviton and Tranium and other diverse processors, really diversifying away from x86 and how this leads to much faster product cycles, faster tape out, lower costs. And our premise was that everyone in the data center is going to competes, is going to need a Nitro to be competitive long-term and customers are going to gravitate toward the most economically favorable platform. And as we describe the landscape with this chart, we've updated this for this breaking analysis. And we'll come back to Nitro in a moment. This is a two-dimensional graphic with net score or spending momentum on the vertical axis and overlap, formerly known as market share or presence within the survey, pervasiveness, that's on the horizontal axis. And we plot various companies and products and we've inserted VMware's net score breakdown, the granularity in those colored bars on the bottom right. Net score is essentially the green minus the red and a couple of points on that. VMware in the latest survey has 6% new adoption. That's that lime green, it's interesting. The question Broadcom is going to ask is how much does it cost you to acquire that 6% new? 32% of VMware customers in the survey are increasing spending, meaning they're increasing spending by 6% or more, that's the forest green. And the question Broadcom will dig into is what percent of that increased spend that you're capturing is profitable spend. Whatever isn't profitable is going to be cut. Now that 52% gray area, flat spending, that is ripe for the Broadcom picking. That is the fat middle and those customers are locked and loaded for future rent extraction via perpetual renewals and price increases. Only 8% of customers are spending less, that's the pinkish color and only 3% are defecting. That's the bright red, so very, very sticky profile. Perfect for Broadcom. Now, the rest of the chart lays out some of the other competitor names and we've plotted many of the VMware products so you can see where they fit. You know, they're all pretty respectable on the vertical axis, that's spending momentum but what Broadcom wants is that core ESX vSphere base where we've superimposed the Broadcom logo. Broadcom doesn't care so much about spending momentum, it cares about profitability, potential and momentum. AWS and Azure, they're setting the pace in this business in the upper right corner. Cisco, very huge presence in the data center. As does Intel, they're not in the ETR survey but we've superimposed them. Now Intel of course is in a dogfight with NVIDIA, the ARM ecosystem, AMD, don't forget China. Okay, you see Google Cloud Platform is in there. Oracle is also on the chart as well, somewhat lower on the vertical axis but it doesn't have that spending momentum but it has a big presence and it owns a cloud as we've talked about many times and it's highly differentiated. It's got a strategy that allows it to differentiate from the pack. It's very financially driven, it knows how to extract lifetime value. You know, Safra Katz operates in many ways, similar to what we're seeing from Haktan and company, different from a portfolio standpoint, Oracle's got the full stack, et cetera, so it's a different strategy but very, very financially savvy. You can see IBM and IBM Red Hat in the mix and then Dell and HP, I want to come back to that momentarily to talk about where value is flowing and then we plotted Nutanix, which with Acropolis could suck up some V-tax avoidance business. Now notice Symantec and CA, relatively speaking in the ETR survey, they have horrible spending momentum, as we said. Broadcom doesn't care. Haktan is not going for growth at the expense of profitability so we fully expect VMware to come down on the vertical axis over time and go up on the profit scale. Of course, ETR doesn't measure the profitability here. Now back to Nitro. VMware has this thing called Project Monterey. It's essentially their version of Nitro and will serve as their future architecture diversifying off x86 and accommodating alternative processors and a much more efficient performance, price and energy consumption curve. Now one of the things that we've advocated for, we said this about Dell and others including VMware to take a page out of AWS and start developing custom silicon to better integrate hardware and software and accelerate multi-cloud or what we call super cloud. That layer above the cloud not just running on individual clouds. So this is all about efficiency and simplicity to own this space. And we've challenged organizations to do that because otherwise we feel like the cloud guys are just going to have consistently better costs not necessarily price but better cost structures. But it begs the question, what happens to Project Monterey? Octane and Broadcom, they don't invest in something that is unproven and doesn't throw off free cash flow. And it's not going to pay, if it's not going to pay off for years to come they're probably not going to invest in it. And yet Project Monterey could help secure VMware's future and not only the data center but at the edge and compete more effectively with cloud economics. So we think either Project Monterey is toast or the VMware team will knock on the door of one of Broadcom's 20 plus business units and say, guys, what if we work together with you to develop a version of Monterey that we can use and sell to everyone and be the arms deal and everyone to be competitive with the cloud and other players out there and create the de facto standard for data center performance and super cloud. I mean, it's not outrageously expensive to develop custom silicon. Tesla is doing it for example and Broadcom obviously is capable of doing it. It's got good relationships with semiconductor fabs. But I think this is going to be a tough sell to Broadcom unless VMware can hide this in plain sight and make it profitable fast like AWS most likely has with Nitro and Graviton. Then Project Monterey and our pipe dream of alternatives to Nitro in the data center could happen but if it can't it's going to be toast. Or maybe Intel or Nvidia will take it over or maybe the Monterey team will spin out of VMware and do a Pensando like deal and demonstrate the viability of this concept and then Broadcom will buy it back in 10 years. Okay, here's a double click on that previous data that we put in tabular form. Okay, it's how the data on that previous slide was plotted. I just want to give you the background data here. So net score spending momentum is sorted on the left. So it's sorted by net score in the left hand chart. That was the Y axis in the previous data set. And then shared N or presence in the data set is the right hand chart. In other words, it's sorted on the right hand chart, right hand table. Okay, that right most column is shared N. You can see it's sorted top to bottom. And that was the X axis on the previous chart. The point is not many on the left hand side above the 40% line. Okay, VMware cloud on AWS is, it's expensive. So it's probably profitable and it's probably a keeper. We'll see about the rest of VMware's portfolio, like what happens to Tanzu, for example. On the right, we drew a red line just arbitrarily at those companies and products with more than a hundred mentions in the survey, everything but Tanzu from VMware makes that cut. Again, this is no indication of profitability here. And that's what's going to matter to Broadcom. Now let's take a moment to address the question of Broadcom as a software company. You know, what the heck do they know about software, right? Well, they're not dumb over there and they know how to run a business. But there is a strategic rationale to this move beyond just doing portfolios and extracting rents and cutting R and D, et cetera, et cetera. Why, for example, isn't Broadcom going after coming back to Dell or HPE? You could pick up for a lot less than VMware and they got way more revenue than VMware. Well, it's obvious, software's more profitable, of course, and Broadcom wants to move up the stack. But there's a trend going on, which Broadcom is very much in touch with. First, it sells to Dell and HPE and Cisco and all the OEM, so it's not going to disrupt that. But this chart shows that the value is flowing away from traditional servers and storage and networking to two places. Merchant Silicon, which itself is morphing. Broadcom, and we focus on the left-hand side of this chart, Broadcom correctly believes that the world is shifting from a CPU-centric center of gravity to a connectivity-centric world. We've talked about this on theCUBE a lot. You should listen to Broadcom's COO, Charlie Cowis, speak about this. It's all that supporting infrastructure around the CPU where value is flowing, including, of course, alternative GPUs and NXPUs, NPUs, et cetera, that are sucking the value out of the traditional X86 architecture offloading some of the security and networking and storage functions that traditionally have been done in X86, which are part of the waste right now in the data center. This is that shifting dynamic of Moore's law, Moore's law not keeping pace. It's slowing down. It's slower relative to some of the combinatorial factors when you add up in all the CPU and GPU and NPU and accelerators, et cetera. So we've talked about this a lot in Breaking Analysis episodes. So the value is shifting left within that middle circle and it's shifting left within that left circle toward components other than CPU, many of which Broadcom supplies. And then you go back to the middle, value is shifting from that middle section that traditional data center up into hyperscale clouds and then to the right toward infrastructure software to manage all that equipment in the data center and across clouds. And look, Broadcom is an arms dealer. They simply sell to everyone, locking up key vectors of the value chain, cutting costs and raising prices. It's a pretty straightforward strategy, but not for the fate of heart. And Broadcom has become pretty good at it. Okay, let's close with the customer feedback. I spoke with ETR's Eric Bradley this morning. You know, I both reached out to VMware customers that we know and got their input. And here's a little snapshot of what they said. I'll just read this. Broadcom will be looking to invest in the core and divest of any underperforming assets right on. That's just what we were saying. This doesn't bode well for future innovation. This is a CTO at a large travel company. Next comment, we're a carbon black customer. VMware didn't seem to interfere with carbon black, but now we're concerned about short-term disruption to their tech roadmap. And long-term, are they going to split and be sold off like Symantec was? This is a CISO, the large hospitality organization. Third comment, I got directly from a VMware practitioner, an IT director at a manufacturing firm. This individual said moving off VMware would be very difficult for us. We have over 500 applications running on VMware and it's really easy to manage. We're not going to move those into the cloud and we're worried Broadcom will raise prices and just extract rents. Last comment we'll share is Broadcom sees the cloud data center and IoT is their next revenue source. The VMware acquisition provides them immediate virtualization capabilities to support a lightweight IoT offering. Big concern for customers is what technology they will invest in and innovate and which will be stripped off and sold. Interesting. I asked David Floyer to give me a back of napkin estimate for the following question. I said, David, if you're running mission critical applications on VMware, how much would it increase your operating costs moving those applications into the cloud? Or how much would it save? And he said, Dave, VMware is really easy to run. It can run any application pretty much anywhere and you don't need an army of people to manage it. All your processes are tied to VMware. You're locked and loaded. Move that into the cloud and your operating cost would double by his estimates. Well, there you have it. Broadcom will pinpoint the optimal profit maximization strategy and raise prices to the point where customers say, you know what? We're still better off staying with VMware. And sadly for many practitioners, there aren't a lot of choices. You could move to the cloud and increase your costs for a lot of applications. You could do it yourself with say Zen or OpenStack. Good luck with that. You could tap Nutanix. That will definitely work for some applications but are you going to move your entire estate, your application portfolio to Nutanix? It's not likely. So you're going to pay more for VMware and that's the price you're going to pay for two decades of better IT. So our advice is get out ahead of this. Do an application portfolio assessment. If you can move apps to the cloud for less and you haven't yet, do it. Start immediately. Definitely give Nutanix a call but you're going to have to be selective as to what you actually can move. Forget porting to OpenStack or do it yourself hypervisor. Don't even go there. And start building new cloud native apps where it makes sense and let the VMware stuff go into managed decline. Let certain apps just die through attrition. Shift your development resources to innovation in the cloud and build a brick wall around the stable apps with VMware. As Paul Moritz, the former CEO of VMware said, quote, we are building the software mainframe, unquote. Now the marketing guy's going to hold it and said, Paul, stop saying that. But it's true. And with Broadcom's help that day will soon be here. Okay, that's it for today. Thanks to Stephanie Chan who helps research our topics for breaking analysis. Alex Meyerson does the production and he also manages the breaking analysis podcast. Kristin Martin and Cheryl Knight helped get the word out on social and thanks to Rob Hoef who was our editor-in-chief at SiliconANGLE.com. Remember these episodes are all available as podcasts wherever you listen, just search breaking analysis podcast. Check out ETR's website at ETR.ai for all the survey action. We publish a full report every week on wikibon.com and siliconANGLE.com. You can email me directly at David.Valante or comment on our LinkedIn posts. This is Dave Vellante for theCUBE Insights, powered by ETR. Have a great week, stay safe, be well, and we'll see you next time.