Summary
- Broadcom has a successful M&A track record.
- 5G and IoT create strong potential growth catalysts.
- Although Broadcom faces near-term headwinds with trade, the future looks positive as more advanced semiconductors are likely to be needed.
Broadcom: Company & Segment Information
Broadcom (AVGO) is a global developer of a wide range of semiconductors and infrastructure software. The company’s focus is on complex digital and mixed signal complementary metal oxide semiconductors [CMOS] and analog III-V products. Broadcom’s semis are found in the following products: broadband access products, home connectivity, set-top boxes, smartphones, telecommunications, data center servers/storage systems, factory automation, power generation/alternative energy systems, and electronic displays.
Broadcom differentiates their products through high performance design and by developing products for target markets. The company leverages their intellectual property to produce products for niche markets. Broadcom focuses on markets that can achieve high profit margins.
The Wired Infrastructure segment (about 42% of total revenue) is poised for future growth as broadband technology and related products continue to advance with improved performance, creating the need for new updated modems, routers, and related tech. The ethernet switching and routing portion of this segment is likely to benefit from the expected ethernet industry market growth from $25 billion in 2018 to $70 billion by 2025.
The Wireless segment which comprises 21% of Broadcom’s total revenue is poised to grow from the increased use of RF products and applications. The global RF communications market is projected to grow at a CAGR of 14% by 2025. The growth for this segment is likely to get a strong boost from the shift to 5G technology. This should keep demand strong for Broadcom’s semiconductors for multiple years.
The Enterprise Storage segment (22% of total revenue) also has a bright future as the data storage market is expected to grow at a CAGR of 12.5% by 2024. The growth is expected to be driven by a significant increase in data volume to support the IoT market and the use of laptops, smartphones, and cloud computing.
source: Broadcom Investor Presentation June 2019
Strengths
Broadcom has a number of internal strengths that can help drive growth and allow the company to remain a leader in the semiconductor industry.
- Broadcom established itself as a well-respected leader in the semiconductor industry with the ability to effectively innovate. The company spends over 18% of total revenue on research & development. This helps the company keep up with the rapid advancements in technology.
- The company has a wide array of semiconductor products. This gives the company diversification across wired, wireless, and data storage markets.
- Their strong engineering expertise allows for the continuous development of innovative products that are adapted to new and improved applications.
- Broadcom has a strong track record for M&A. The most recent acquisitions in the past few years were CA Technologies and Brocade Communications. The latest CA Technologies acquisition is expected to increase Broadcom’s long-term EBITDA margins above 55% (current EBITDA margin is 46.6%).
source: Broadcom Investor Presentation June 2019
- Large set of intellectual property: 20,898 U.S. patents and 1,655 U.S. patents pending. There are only a small number of patents that will expire in the near future and those are not expected to negatively affect their IP.
- Strong cash flow growth: Broadcom tends to achieve consistent growth in operating and free cash flow on an annual basis. This can help the company pay down debt, expand the business, and increase the dividend over time.
source: Broadcom Investor Presentation June 2019
Weaknesses
Broadcom has some internal weaknesses which leaves room for ongoing operational and structural improvements.
- Revenue is highly levered to China (49% of total revenue) as compared to 13% of revenue coming from the U.S. and 38% from other countries. As a result, the current trade war between the U.S. and China creates near-term headwinds and uncertainty for the company.
- The majority of sales are derived from a small number customers. Sales to distributors accounts for 34% of total revenue; Foxconn (world’s largest electronics manufacturer) accounts for 9% to 14% of total revenue.
- The balance sheet contains a high amount of debt of $37.6 billion as compared to $5 billion in total cash. As a result, Broadcom will need to use a portion of their operating cash flow to pay their obligations.
Opportunities
There are multiple opportunities for Broadcom to take advantage of regarding long-term trends in technology.
- The developing 5G and IoT technology creates opportunities for Broadcom to create advanced semiconductors to enable devices to work effectively with various applications.
- Future strategic acquisitions could be sought out to continue the company’s growth and to strengthen the overall business.
- Increase business in other countries: Broadcom could diversify their business geographically, which would make them less dependent on China.
- Increase revenue in the industrial business. Currently the Industrial/Other segment only comprises 5% of total company revenue. There are growth opportunities for factory automation, renewable energy systems, power control, car infotainment systems, and motor controls.
- Broaden the customer base: Broadcom could secure new customers so that they would be less dependent on a small number of revenue sources.
Threats
Broadcom faces various external threats that could hinder growth or cause the loss of market share.
- The trade war between the U.S. and China creates near-term headwinds for the company. There is uncertainty regarding the long-term tariffs rates and how they will affect the company. Unfavorable trade dynamics could hurt the company’s business.
- The company faces competition in each segment. Some main competitors include: Intel (INTC), Finistar (FNSR), NXP Semiconductors (NXPI), ST Microelectronics (STM), Qorvo (QRVO), Skyworks (SWKS), Qualcomm (QCOM), Murata Manufacturing (OTCPK:MRAAY), Cisco (CSCO), Texas Instruments (TXN), Marvell Technology, and Microsemi. Increased competition could take market share away from Broadcom and challenge the company to grow.
- Commoditization of semiconductors: Competitors could create semiconductors that provide similar functionality as Broadcom’s semis in spite of their own IP.
- Issues with suppliers or 3rd party manufacturers could negatively affect the company.
- Unfavorable prices for semiconductors: an oversupply of similar semiconductors in the market could cause prices to fall, reducing potential revenue.
- Government regulations could lead to higher costs. Regulations could be implemented that could make it more expensive to conduct business, reducing earnings.
Long-Term Broadcom Outlook
In the near term, Broadcom faces headwinds with the trade war between China and the United States and the Huawei situation. Broadcom recently cut their annual sales forecast by $2 billion as a result of the ban on exports to China company, Huawei.
Despite this headwind, Broadcom faces plenty of potential growth over the long-term. As technology rapidly advances with 5G and IoT growth developments, more advanced semiconductors will be needed to make these related applications effective. Broadcom stands to benefit as their semiconductors are likely to see growing demand from multiple customers. Keep an eye on the various threats to see if the business would be significantly impacted over the long-term.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article was written by David Zanoni for Kirk Spano’s Margin of Safety Investing service.
Additional disclosure: The article is for informational purposes only (not a solicitation to buy or sell stocks). David is not a registered investment adviser. Kirk Spano is an RIA. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.
