(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)
Broadcom Inc.'s (AVGO) recent acquisition of CA Inc. (CA) for $18.9 billion caught many investors by surprise, and Broadcom's stock was punished as a result. Its stock has fallen by over 16% since June 11, and the sad news is that traders are betting the stock drops even further, by perhaps another 12% by the middle of August, from its current price of approximately $208.
The move by Broadcom to buy CA comes after Broadcom was unable to acquire Qualcomm Inc. (QCOM) earlier this year. The reports of the new deal caught many investors off guard, given the differing business that Broadcom, a chipmaker, and CA, a software company, have. Broadcom's stock has underperformed over the past year, with shares now down by over 15%, versus an S&P 500 that is up about 15%.
Options traders are betting the sharp declines in the stock are not over, and there is more to come by expiration on Aug. 17. The long straddle options strategy suggest shares of Broadcom may rise or fall by nearly 8% from the $210 strike price. But the number of bets the stock will fall outnumbers the bets that the shares will increase by about 2 to 1, with roughly 3,000 open put contracts. It places the stock in a trading range of $194 to $226. The number of open puts builds at the $200 strike price with nearly 5,000 open contracts, and with the contracts trading at $4.50, the stock would need to fall by about 7% for a buyer of those options to break even.
Some traders are betting the stock falls even further, to nearly $183.50, a drop of about 12% from the stock’s current price, based on the activity at the $185 strike price for expiration on Aug. 17.
Broadcom's poor stock performance comes as the company faces slowing earnings growth in fiscal 2019. Analysts are looking for revenue growth in 2019 to slow to just 3%, down from over 17.6% this year. Meanwhile, earnings growth is forecast at only 3.5% in 2019.
Cheap Valuation May Not Help
One positive is that the stock is trading at its lowest one-year forward P/E ratio over the past year at just 10.2. But with the recent acquisition, that cheap valuation may not help, as investors try to sort through how CA will be integrated into Broadcom's existing business.
For now there seem to be more questions than answers around Broadcom's newest acquisition. In a sell-first-and-ask-questions-later stock market, Broadcom's stock may continue to feel more short-term pain. At least that is what some traders are betting will happen.
Michael Kramer is the founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.