Broadcom's Industry-Leading Technology And Multiple Growth Opportunities Make It A Compelling Buy

| About: Broadcom Limited (AVGO)

Broadcom (BRCM) 1-Year Share Price Performance

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Financial Summary and Market Data (1/24/13):

  • Quick Ratio: 2.19
  • ROIC: 13.1%
  • EBITDA Margin: 16.7%
  • Profit Margin:12.55%
  • Shares Sold Short as % of Float: 1.2%
  • Insider Ownership: 8.0%
  • Institutional Ownership: 82.3%
  • Share Price: $34.07
  • Shares Outstanding: 512 MM
  • Market Cap: $17,443 MM
  • Average Volume (3M): 7,111,800
  • 52 Week Range: 28.60 - 39.66
  • 2012 EST EPS: $2.91
  • NTM PE: 10.66
  • 2012 Price /FCF: 15.18
  • 2012 Price /Sales: 2.59

Source - S&P capital IQ

Broadcom Company Description:

Broadcom is a leading fabless semiconductor solution provider for wired and wireless connectivity. Its products enable the delivery of voice, video, data and multimedia to and throughout the home, business and mobile environment. the Company is the industry leader in providing wireless connectivity , near field communication (NYSEMKT:NFC) , 2G-4G mobile wireless baseband processors, and network communication chips in servers to process incoming data. Baseband processors manage network connection & communication data processing. This is a distinct from main processors which manage user interface and application data processing. With 4,500 U.S. and 1,800 foreign patents, Broadcom has one of the broadest intellectual property portfolios addressing the needs of all forms of communication systems.

Upcoming Product Launches & Near Term Catalysts:

Ultra high definition TV home gateway chip: The amount of data needed to deliver streaming ultra high definition media to upcoming TV designs (4K etc), is going to increase exponentially. Broadcom's new proprietary compression codec and processing chip is able to cut in half the compressed data needed to stream HDTV, allowing the streaming of HD content on current modems and broadband speeds. This will dramatically improve picture quality and on large displays and the speed at which devices will be able to stream content.

Wi-Fi enabled TVs: Broadcom had several design wins among the major consumer eletronic producers to provide the Wi-Fi chips in upcoming Wi-Fi enables TVs. The release of these products onto the market will be a significant driver of Broadcom's revenue growth.

802.11ac Modems & Routers (5G Wi-Fi:) : 802.11ac is a new wireless computer wireless networking standard providing ability to communicate on the 5GHZ band. Standard finalization is in late 2012, with final 802.11 ac approval in late 2013. According to a study, devices with the 802.11ac specification are expected to be common by 2015 with an estimated one billion spreading worl wide. Theoretically, this specification will enable multi-station WLAN throughput of at least 1 gigabit per second and a maximum single link throughput of at least 500 megabits per second compared to speeds of 56 megabits per second in today's 802.11n. Broadcom will be supplying the networking chips for this new standard and benefit considerable from the product update cycle.

Differentiation from Percieved Competitors: Often Broadcom is compared to other fabless semiconductor companies such as Qualcomm (NASDAQ:QCOM), Intel (NASDAQ:INTC), and Texas Instruments (NYSE:TXN). Although all of these companies produce semiconductor processing chips, Broadcom is unique in that its focus is on communication processing chips, such as the processors that interpret and direct network data, manage connection to Wi-Fi networks and process connection and communication between devices. Additionally, Broadcom has made a foray into graphics proccessing units, as discussed above, and will be used to process streaming media to future HD TVs. In contrast, its percieved competitors' focus is central processing units, or the processors that interpret and carry out commands from the user interface and applications. These are completely different segments, thus changes in the CPU market have no effect on Broadcom's core business. Recently, Qualcomm and Intel have introduced network communications processors that do directly compete with Broadcom's core operations. However, competitors have no won any significant design wins over Broadcom and Broadcom has a substantial lead over its competitors in the capabilites of its products. I expect this lead to be maintained in the future with Broadcom's intellectual patent portfolio and its aggressive R&D program.

Growth Opportunities:

Currently, Broadcom's products are in nearly every device with any sort of wireless communication and a number of wired communication devices such as; smartphones, tablets, PCs, laptops, bluetooth products, gaming consoles GPS devices, and ethernet controllers (the processor within your high speed modem). I expect Broadcom to benefit substantially from the accelerating growth of the smartphone and tablet market. Moreover, cannibalization of the PC market is not a concern as slower PC sales will be more than offset by smartphone and tablet growth. I foresee Broadcom's wired communication division (develops ethernet controllers and related products) to have flat to modest growth as high speed internet will remain in demand for the foreseeable future and potential competition with highspeed 4G solutions for homes and business is probably a decade away from being viable.

However, I believe the proliferation of NFC in new devices is the most exciting and underappreciated potential growth area in Broadcom's future. I expect the theme of this decade to be the integration of all of your car, electronics, appliances, payments etc into a single communicating ecosystem. What this means is in the future all of the appliances and electronics in your home will be able to communicate with one another and with the outside world. Examples of this trend are already visible as smartphones are being adapted to send payment such as google wallet and the ability to watch content on your tablet that is saved on your DVR. In the future you will be able to use your smartphone to communicate your TV, dishwasher, refrigerator etc to recieve alerts and manage their function. Moreover, these devices will be able to communicate amongst one another. Imagine as you turn on your dishwasherit communicates its additional power consumption to all of the other devices in your home so they can adjust their power consumption, directing it to where it is most needed. This technology enabling this revolution is already here in NFC processing chips and networking communication chips produced by broadcom. As this integration of devices progresses Broadcom's target markets will expand exponetially. Broadcom is the undisputed leader in this technology and holds a fortress intellectual patent portfolio to protect its dominance in the forseeable future. Thus I expect Broadcom to be a central beneficiary as this theme takes place.

Valuation: Currently Broadcom is valued at 10.66x NTM EPS. I believe a fair value NTM EPS multiple is 15x considering Broadcom's multiple potential growth drivers, upcoming products and catalysts and its stable, broad revenue base. This implies a fair PT of $49.35, or a 45% 12 month return potential from today's share price.

Risks: The risks that face Broadcom include supply and manufacturing disruptions, margin compression and design losses due to increasing competition in the semiconductor communications space, slower than anticipated growth in the mobile market and possible failure to execute on key upcoming product cycles. I view the possibility of these risks to be limited and believe the potential for a 45% return more than compensates for the risk.

Conclusion: Broadcom is one of the few technology companies on the market today that has a substantial competitive moat and universally used products that insulate the Company from reliance on the performance of any one market or emerging consumer trends. The company will be able to maintain its portfolio of technologically superior products with its patents and substantial R&D capabilities. With 45% potential upside and minimal downside risk I find Broadcom an uncommonly compelling buy.

Disclosure: I am long BRCM, QCOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.