While for now, Avago Technologies will be preoccupied with the immense and time-consuming effort of its integration process with Broadcom, not too long afterwards, it would not be surprising if there would be a spin-off that would include a large number of the combined company’s optical networking assets. The progressive shift from a technology-focused firm to one that is more business-oriented should inevitably go beyond just making further sizable acquisitions, but to improve the balance sheet through aggressive divestment. Although KKR does not hold a stake in Avago anymore, we believe the supplier has been heavily influenced by the private equity firm’s modus operandi – purchase assets, find value, package parts, and sell off.
One may easily presume that calling the merger, “Broadcom” instead of “Avago” probably has significance for its future technology direction. Within our industry, the latter name has a connotation more nearly associated to optical componentry than the former.
Avago must realize that the gross margins on these products are not going to really improve anytime in the foreseeable future. As a bare minimum, the vendor would most likely be interested in ridding itself of many of its own devices under its current heading, “fiber optics,” within its present category of “wired infrastructure.” They are the wide variety of transceivers in such markets as Ethernet, high performance computing, and metro networking – the vast majority of which in the first two categories run on multimode fiber, along with a handful on copper. (The other two classifications for transceivers are for storage and for base stations.) Despite the bulk of the discussion in the business about the shift to IP, and the expanding need for high capacity, Avago still carries as many as 12 SONET/SDH parts for metro applications, with up to eight of them only at the OC-3/STM-1 level.
As we have pointed out in the past, Avago’s position in the 850nm market is a fairly attractive one with sustainable sales well into the future, and the bulk of the competition from only one other supplier. Barriers to entry are quite high in that producing high-quality VCSELs is not easy in that the fixed costs are 50 percent or higher compared to the variable expenditures. Also, manufacturing high-quality VCSELs is not easy, and a big challenge is staying up with the latest solutions for uniformity and reproducibility.
Broadcom certainly has its share of transceivers, which could potentially be thrown into the mix of a new spin-off. There are other possibilities in the optical realm for inclusion or to be sold off separately to other suppliers (as happened in the case of the LSI acquisition) based on either decisions over strategic direction or determinations that future sales/margins look unappealing. Examples might include Broadcom’s passive optical network gear for access applications or Avago’s industrial equipment. (Another wild card is that both Broadcom and Avago have extensive intellectual property in PAM-4, which given all of the excitement over its usage for high-end applications by the IEEE standards groups could make a package of optical offerings more attractive to a lot of buyers.)
Given that the bulk of the product line of this spinoff would not result in a high level of profitability, it should go without saying that taking it public is out of the question.
[written by Mark Lutkowitz]