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Finding Upside with Broadcom

Posted on: August 31, 2008 - Email Article - Printable Version

Steve Murray

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“Connecting Everything,” a perfect company slogan for a company which has been doing just that. Broadcom [BRCM: 17.58, +0.01 (+0.06%)], a semiconductor company based in Irvine, CA has had explosive growth recently. Many of their products are regarded as products of the wireless and multi-face future. Their low-cost, high-speed multi functioning “system-on-a-chip” semiconductors and the software that combines voice, video, data, and multimedia applications are best-of-breed in the industry. In addition, Broadcom has contracts with other highly regarded computer companies such as Apple, Alcatel, Cisco, Dell, EchoStar, HP, IBM, LG, Nintendo, Nokia, Nortel Networks, Pace, Samsung and many others. Although they have a lot of contracts with these big name companies, they also do a lot of business with smaller companies. In 2007, the leading five customers accounted for about 40% of total revenue.

Guiding the Future

Broadcom is moving quickly to enter the digital television industry. This past Monday, they announced that they will buy Advanced Micro Devices’ digital television chip business for $192.8 million in cash. This move comes ahead of the FCC’s new regulation on broadcasting companies in which they will be forced to broadcast only in digital on February 17^th. Since the division wasn’t a main part of AMD’s business, they were unable to monopolize on it. Broadcom believes it will be able to churn a profit in this business relatively soon.

Apple’s Contract

One of Broadcom’s most famous products is the touch-screen controller chip which is behind Apple’s [AAPL: 94.58, +3.83 (+4.22%)] iPhone. But Broadcom also provides Apple’s iPhone with its newly introduced GPS navigation chip. Indirect exposure to the industry’s new hottest smart phone, which has now been cleared for use in major corporations for business email, is yet another huge growth driver going forward.

Core Businesses

Broadcom also provides chips to Motorola’s [MOT: 4.48, -0.19 (-4.07%)] cable set-top boxes as well as wireless routers sold by Netgear [NTGR: 11.78, -0.19 (-1.59%)]. Within the past few years, Broadcom has landed many deals with some of the trendiest technologies including Blu-ray, Wi-Fi, Bluetooth, and digital TV. All of these products have high growth potential in the next few years. Blu-ray recently won the high definition DVD battle against HDDVD, as the quality of Blu-ray is significantly better than HDDVD. I continue to believe that Bluetooth technology is a great place to be now, as many wireless headsets have moved towards this technology. Many venture capitalists are funding and starting up companies that are working on creating a domestic U.S. Wi-Fi network, which will provide wireless access across the entire United States. I believe that digital television and high-definition services will soon take over the cable industry, as customers will be forced to upgrade by the FCC in February of 2009. All of Broadcom’s high-growth segments seem to be well positioned to take apart of these new technology developments.

Financial Results

Broadcom’s high growth products boosted their revenue 30% and beat analyst expectations for the second quarter. Earnings rose by over 200% if you exclude acquisition related items and one time items. Their mobile and wireless business posted a 50% gain in revenue year-over-year. After their earnings report, analysts have raised their earnings estimates. “They are in the right markets with the right products,” says Daniel Berenbaum, communications semiconductor analyst at Cowen & Co. “You have to like that and you have to like a company that has executed so well.”

Broadcom currently trades with a beta of 2.5, which is a little high compared to the broader industry. However, at $24 a share and a market cap of $16 billion, Broadcom seems like a steal as they trade at a forward P/E of less than 15 compared to a trailing P/E of over 40. Analysts are estimating that their revenues will increase by 27% in 2008 and 17% in 2009 due to robust end-market demand for their communication offerings. Gross margins should also narrow to around 51% in 2009 from an anticipated 52% in 2008 as sales will move to lower-margin products. EPS is expected to grow to $0.94 in 2009 from an estimate of $0.80 in 2008. Also, some analysts have their price target in the range of $35-38, but I would have to lean more towards the $30-33 range looking out 6-12 months. Look for them to pop in the near future from contracts landed from new digital television contracts.

-Steve Murray

Disclosure: The author of this article is long BRCM.

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