Broadcom Stumbles, But The Street Forgives

By Stephen D. Simpson, CFA | February 05, 2013 AAA

The next time Wall Street is fair will be the first time, but I imagine investors in some of the beaten-up tech stocks are looking at Broadcom (Nasdaq:BRCM) with a little envy or resentment. Although Broadcom's guidance for the next quarter was pretty soft, as the Street basically shrugged it off and gave the company/stock a pass. Broadcom enjoys tremendous support among sell-side analysts, but the company still looks like an appealing play on growth in the mobile/wireless, networking and home connectivity markets.

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An OK Fourth Quarter
Broadcom revised guidance for the fourth quarter back at its December analyst day, so there weren't too many surprises in store for this quarter.

Revenue rose 14% (as expected) from last year, but did decline about 2% from the third quarter. As is usually the case, there was a wide spread of results by segment. Broadband was the weakest on an annual comparison (up 10%), but the strongest on a sequential basis (up 1%) and the only one to show growth. Mobile/wireless saw 16% growth from last year and 1% contraction from the third quarter, while networking (infrastructure) rose 21% and fell 9%, respectively.

BRCM was slightly deficient on gross margin, as non-GAAP gross margin rose about a point and a half but came in about a quarter-point short of estimates. The company made it back on operating expenses, however, and operating income rose 13% from the year-ago period (while falling 2% sequentially).

Earnings quality also looked pretty good for the quarter, as accounts receivable, inventory and cash conversion numbers all looked good.

SEE: 6 Things To Look For In Earnings Reports

Disappointing Guidance - the Pause Before the Growth?
Investors were a little nervous about guidance going into this quarter, and Broadcom showed that the concern was well-placed. While analysts had been looking for a sequential revenue decline of about 3%, management guided to a 9% contraction with lower margins as well.

The softness looks pretty broad. An inventory correction at Samsung and lower-than-expected unit shipments for Apple (Nasdaq:AAPL) seem to be responsible for the mobile/wireless weakness, while management also continues to see soft carrier spending and market conditions for networking, similar to what others like Altera (Nasdaq:ALTR) have said.

There are credible reasons to expect the year to get better. Samsung will be ramping up the Galaxy S4 before mid-year. Cisco (Nasdaq:CSCO), Juniper (Nasdaq:JNPR) and other top-tier networking companies will be launching products with Broadcom's Trident II chipset in the second half. Broadcom is also well positioned for the ongoing growth of the "Internet of things" in areas such as set-top boxes and home connectivity.

Still Plenty of Work to do
Broadcom has been increasing its share in mobile baseband, but it's still well behind Qualcomm (Nasdaq:QCOM) in overall share. Also unlike Qualcomm, Broadcom is relatively concentrated around Apple and Samsung (in connectivity) and does not have the same toll-taking IP. That said, Broadcom has excellent IP and is actively targeting share growth in this market. I don't expect Broadcom to ever catch Qualcomm in terms of overall share, but I believe the company could get the No.2 slot and maybe a quarter of the market.

At the same time, Broadcom needs to make sure it keeps what it has and builds on it. As much as Broadcom wants more share in the mobile baseband market, Freescale (NYSE:FSL), Cavium (Nasdaq:CAVM), Marvell (Nasdaq:MRVL) and Qualcomm want to take share in Broadcom markets like networking and broadband.

SEE: A Primer On Investing In The Tech Industry

The Bottom Line
Broadcom's lower market share and financial history lead me to be less aggressive with my projections than for Qualcomm. That said, a long-term revenue growth estimate of 5% and a long-term free cash flow (FCF) growth estimate of 5 to 6% still supports a fair value above $40 and offers upside if Broadcom can deliver stronger and/or more consistent growth in the coming years.

It's no coincidence that Broadcom and Qualcomm both seem about 25% below my fair value targets today. In Broadcom, investors have a riskier play with more share-growth and FCF growth potential, while Qualcomm seems like the safer (or at least more established) option. Both are more popular with the Street than I'd like (large numbers of "Buy" ratings), but both look like promising ways to benefit from ongoing mobile/wireless growth.

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

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