Everybody Loves Broadcom, And Maybe You Should Too

By Stephen D. Simpson, CFA | February 01, 2012 AAA

Normally I get skeptical whenever I see a stock uniformly supported by major Wall Street firms. After all, if a dozen major analysts are already out there pounding the table, how much good news is left undiscovered and unappreciated? In the case of Broadcom (Nasdaq:BRCM) the answer may well be "more than you think" as the company continues to leverage good technology into more new products and markets.

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A Pretty Good End to the Year
Although December was the winter of discontent for chip companies, Broadcom actually did pretty well all things considered. Revenue did fall about 7% on both an annual and sequential comparison. The company's mobile/wireless business was strongest (down 4 and 7%, respectively), while broadband (down 12 and 3%) and infrastructure (down 7 and 13%) were weaker.

Most of Broadcom's peers like Qualcomm (Nasdaq:QCOM) and Texas Instruments (NYSE:TXN) show pretty weak margins when revenue fades, but Broadcom has done surprisingly well in this regard. Reported GAAP gross margin stayed basically flat across the board, while reported operating income actually rose - up 4% from last year and 3% from the prior quarter on lower SG&A and flat R&D. On an adjusted basis (reversing charges and items), operating income was down about 17% from last year. ((For more on R&D, see Buying Into Corporate Research & Development (R&D)).

Mobile Master Blaster
At the risk of getting really esoteric here, Broadcom sort of reminds me of Master Blaster from the third "Mad Max" movie - a smart, small company that benefits from the strength of a behemoth, or in this case, two behemoths.

Apple (Nasdaq:AAPL) accounts for well over 10% of Broadcom's revenue, and Apple uses Broadcom chips in literally almost every product they sell. Samsung, too, is a major customer as although it prefers Qualcomm in its higher-end products, Broadcom has numerous sockets in lower-end products. As these are the two preeminent smartphone makers today, that's a pretty good situation for Broadcom.

Moving Beyond Mobile
Outside of phones, it's a dicier story. Infrastructure was weak this quarter on weakness in switching - no real surprise given the carrier market and the results reported by companies like Juniper (NYSE:JNPR). Looking ahead, though, this spending will recover at some point and Broadcom can also look forward to gaining share within Cisco (Nasdaq:CSCO).

Likewise, broadband is a mixed blessing. Results were down this quarter because of discontinued BluRay and DTV products, but there's still a solid addressable market here.

The Bottom Line
Although investors fear the risk that Qualcomm (and perhaps Texas Instruments) will chip away at the connectivity business, the reality is that Broadcom has a nearly unrivaled soup-to-nuts array of features within its targeted markets. Moreover, while there are risks of Broadcom losing business to rivals, there are also opportunities for Broadcom to win business and the recent track record has been pretty favorable in that regard.

Broadcom looks a little expensive by metrics like trailing P/E and EV/EBITDA, but I seldom go with those over cash flow. Moreover, trailing EV/revenue is another metric that draws notice in the chip sector and Broadcom is actually in pretty good shape in that respect.

While looking at cash flow, expecting some slight improvement in free cash flow conversion and mid-single digit revenue growth out through 2016, can lead to a target in the $40's. Odds are that the cyclicality of the semiconductor market will preclude any sort of smooth revenue ramp, but I do believe this company can eventually achieve those sorts of earnings. With that in mind, and even acknowledging how widely-known and popular this stock is it is hard to argue with buying Broadcom today. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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