Broadcom's Earnings Could Be Soft, But Long-Term Outlook Is Intact

| About: Broadcom Limited (AVGO)

Despite an annual contraction in the overall semiconductor industry, Broadcom (BRCM) -- a leading semiconductor provider for wired and wireless communications -- closed its fiscal 2012 with an 8% increase in revenues, though higher operating expenses lowered its net income by 22%. Rapid innovation and strong execution helped the company continuously expand its top line quarter over quarter in 2012, barring a marginal sequential decline (2.3%) in Q4 2012, primarily on account of seasonal factors and macro weakness. Broadcom is set to announce its Q1 2013 earnings Tuesday, April 23, and the company anticipates slower growth this quarter as well.

While we agree that macro headwinds might limit Broadcom's short-term growth, we believe in its long-term growth potential. The company gained additional market share in all of its business segments -- connectivity and baseband, network solutions and broadband last year, which is proof of its improving competitiveness in the market. With strong cash flows, a robust product road map for 2013 and beyond, as well as accelerating design wins across business segments, we believe that Broadcom has strong fundamentals to support a higher valuation.

Here are some of the factors that we believe will accelerate Broadcom's growth momentum in the coming quarters.

Leadership in Connectivity Solutions

Accounting for a majority share in the mobile wireless market, Broadcom is the market leader in mobiles and tablets, with a presence in the Apple iPad, Samsung Tab, and Motorola Zoom. The company has enjoyed major success with its connectivity solutions in cell phones, most notably the main WLAN slot in the iPhone. Broadcom shipped around 200 million connectivity combos in Q4 2012 alone, and its wireless connectivity solutions grew faster than its overall mobile and wireless business in 2012.

Smartphones and tablets market is the fastest growing segment in the semiconductor industry, and the former represents the majority of Broadcom's connectivity business. We anticipate the mobile market to continue growing at a rapid pace. Here are some facts that support our claim:

  • Smartphone shipments increased by 43% in 2012 ($675 million), accounting for 39% of the mobile phone market. Gartner forecast the mobile phone shipments to climb to 2.2 billion units by 2016, and we estimate smartphones to account for 60% of the shipments.
  • IDC estimates the global tablet shipments reached 117 million units in 2012, a 65% increase from 2011. This market is forecasts the market to rise to over 260 million units by 2016.

In 2012, Broadcom expanded its product portfolio with 5G Wi-Fi smartphone chips and NFC quad-core chips, which targets growth in mass market mobile phones as well as high-end mobile phones and devices. We estimate the company to retain its share in the connectivity market over our review period.

Riding the Smartphone Boom With an Expanded Product Portfolio

Historically, Broadcom has lagged its competitors in the baseband and application processors market. However, with a continuous improvement in its product portfolio, it has managed to increase its market share in the last few years.

Based on our belief that smartphone and tablet shipments will continue to drive growth in the future, we estimate the baseband and application processor market to grow at a CAGR of 10% through 2019. With a significant improvement and the addition to its mobile product portfolio last year, Broadcom now ranks among the top four players in the baseband and smartphone application processor market. The launch of its first LTE-compatible baseband chip, its growing success in the low-cost smartphone domain, and Texas Instruments exit from the baseband market are factors that support our belief of Broadcom gaining more market share in the future. (See also: "Why Broadcom Is Cheap And Will Gain Market Share From The Smartphone Boom.")

Strong Set-Top Demand From Developing Countries

With 15% higher set-top box shipments, Broadcom gained additional market share and delivered strong growth and profits throughout 2012. It benefits from strong demand for advanced set-top boxes in developed countries as service providers aggressively transition their subscribers to advanced services, and the emerging markets continue to increase their digital transition. The company witnessed a number of positive developments last year and offers service providers a complete solution across the access spectrum, from DSL and cable to PON.

Despite Lower Enterprise Spending, Broadcom Manages to Retain Its Foothold in the Networking Market

Owing to reduced data center and enterprise spending, and lower service provider capital expenditures last year, Broadcom marked an 8.5% sequential decline in its networking revenues. Though the weak conditions might persist this quarter as well, we believe that Broadcom has the requisite IP to meet the growing customer demand in the network market when the macro situation improves.

In addition to introducing the first 28 nm multicore network chip last year, Broadcom also launched the latest generation of Ethernet switches for the enterprise market, which are optimized to address increasing workforce mobility. Equipped with NetLogic’s leading multi-core embedded processor solution, Broadcom has managed to expand its potential addressable market and earn higher revenue from the infrastructure and networking market. We believe that the upward trend will continue in the future as well.

We will update our price estimate of $44 for Broadcom after the Q1 2013 earnings release.

Disclosure: No positions.