Broadcom Corporation (BRCM) 2013 William Blair & Company Growth Stock Conference Call June 13, 2013 9:40 AM ET
Eric Brandt - Executive Vice President and Chief Financial Officer
Anil Doradla - William Blair
Anil Doradla - William Blair
Alright. Good morning. My name is Anil Doradla, and I cover the semiconductors and wireless sectors at William Blair. For a complete list of disclosures and potential conflict of interest, please visit our website at www.williamblair.com.
It gives me great pleasure to invite Eric Brandt, Senior Vice President and CFO of Broadcom. This is Eric’s first time to our conference and we hope you will be here for many more. For those who are not familiar with the company, Broadcom is a leading provider of semiconductor solutions used across a variety of devices, whether it is downloading your YouTube video on your iPhone over a Hotspot, watching TV over cable or satellite, or providing the broadband connection for your desktops in your home and enterprises, it’s more likely that Broadcom has played a key role in enabling it. Time and again over the last several years, the company has proven its leadership in this hypercompetitive industry. To understand drivers, business trends, catalysts, please join me in welcoming Eric.
So, normally, we present at technology specific conferences. Anil mentioned to me that there maybe a number of journalists in the audience. I actually don’t normally present slides, normally I just take questions. But what I thought I might do is take about 10 or 15 minutes to orient those of you who don’t know much about Broadcom. To Broadcom, I apologize for those of you who know a lot about Broadcom, like (inaudible) sitting here in the front row, but well, I take a few minutes just to give you a little bit of an orientation to our business. The usual cautionary statement, I am not going to spend time reading this to you. Everybody has to do this. I will let you read that on your own. Hopefully, you are a speed reader.
Okay, so moving right along. So, as Anil mentioned, Broadcom is a fairly sizable company in the semiconductor space. In fact in 2012, we were number nine in total semiconductors. If you remove the memory companies, we are number five and darn close to number four in terms of what I will call the logic-based semiconductor companies. We did about $8 billion in revenue last year.
Our business is split between three segments, the home, the hand, and infrastructure. We call them broadband communications, mobile and wireless, and infrastructure and networking. Broadcom is a unique company. I came from the pharmaceutical industry. I thought that pharmaceuticals were more R&D intensive – the most R&D intensive industry in America. I will tell you that they are not. 77% of our 12,000 employees work in R&D.
We are an R&D company. We have nearly 20,000 patents issued and pending. We are in fact I was just at a dinner the other night and our leading patentor inside the company has about 825 patents issued. That makes him about number 35 on the U.S. patent list. By contrast, Thomas Edison, who is number four, only has about a 1,087. So, we are very, very technology-centric, very focused on R&D, and try to leverage that R&D into our business.
Moving to the three segments, the home segment, the home segment is comprised of things you think of when you deliver content in your house. The easiest thing to think of is not the TV itself, we were in the TV business, but the content that is delivered to that TV. What we really do is we move content, we move traffic, we move information, we move video streams all around the globe whether it’s through the Internet, through proprietary networks etcetera. And in your home, we are the market leader in the devices in your home, so, think of that as your set-top-box whether it’s cable, satellite, or IP. We are the market leader in gateways, broadband gateways or broadband modems, whether that’s cable modems, DSL modems, PON, etcetera, we are the leader in those spaces, and provide the content and build the chips to do that. That business last year for us was about a $2.15 billion business grew at about 5%. If you take out the components of the business that we exited, which was the digital TV, that number would be closer to 10%.
Second segment on this page is the hand segment. Think of that as mobile devices, think of that principally as cell phones, tablets, other mobile devices you would carry around. It includes also Wi-Fi, routers, etcetera those types of things. That is our largest business. It represents almost 50% of the company, approaching $4 billion in sales, $3.8 billion in product sales in that business. Most notably and the largest component of that is the Wi-Fi and the combo business that we do enhance it.
And then lastly is the infrastructure networking business. I think of that kind of is the plumbing of the Internet and how information moves around. This principally being switch chips, controller chips, network processors, those types of things, those are the things that we actually do in that part of the business. I mentioned this as I started, but this is the company that is not just an R&D company it’s a voraciously competitive company. Every business we try to compete in, we try to become number one. In the hand and handheld devices, we are number one in Wi-Fi, we are number one in Bluetooth, and we are number one in the combo chips, which combine all of that functionality into individual devices.
In the home, which is where broadband started, we are the number one in satellite set-top-boxes, so if you have a satellite box in your house, it probably has our chip in it. We are number one in cable set-top-boxes. It probably has our chip in it. IP set-top-boxes, which are more new, cable modems, PON modems, DSL modems are all number one markets for Broadcom.
On the infrastructure side, we are also number one in Ethernet switch, Ethernet 5 knowledge-based processors. So, it’s hard to imagine and I did this with my daughter a couple of years ago, if you walk around your house to not find as many as 10 or more Broadcom chips that are in your house or more likely touching various parts of your house. And as a result of those three spectrum, you think about it right the world has gone from sort of processing data, which is still very important to the transmittance or transportation of data, and you look at the various places that data moves and whether it moves from a handheld device to a base station through some wireless infrastructure whether that’s in the ground or in the air to the core network out through cables, back out to corporations or into your home or on to your PC, you are most likely touching some Broadcom chips somewhere along the way. In fact, statistics if you were to try to multiply all these across over 99% of the traffic that crosses the Internet touches a Broadcom chip, just to give you a sense of how pervasive the company is.
Let me take a moment and just talk about the individual businesses and I’ll do just one slide on each. As I mentioned on the broadband or home market, we operate in this market. Think of it again as your set-top-box, your cable providers, your satellite providers, etcetera as well as the people who provide internet services to your home in terms of modems, whether that’s a telco or cable company or some other form. This business typically has been sort of a mid single-digit growing business. If you think of it in developed markets, subscribers are probably relatively flat, but if you look at the bottom line here on this chart, there continues to be a march of new technology, which adds ASP and benefit to the individuals and to the actual service providers that serve your home.
And so whether it’s a fully integrated broadband gateway that has PON or could even have a femtocell in it, has Wi-Fi in it, adding MoCA, high efficiency video codec, which will be the – which will probably be MPEG-5, which has the ability to transmit higher and higher bid levels, video traffic at probably 40% less spectrum requirement. So, some people think of this as an important part of 4K by 2K, which is ultra HD on the right side, the next side of that. It’s actually an important part of your box today. And why is it important part of your box today? It’s an important part of your box today, because even with the current HD spectrum, it can be reclaimed as a result of this new technology.
And the way this typically works is, as you know is the providers typically see the technology into your home before they offer the technology, so don’t be surprised if there is some call about upgrading the boxes in your house, and after you have upgraded the boxes, there has been a call that says, hey, we have a new service and we can give you ultra HD or we can do something else in your home, either through home media servers, which is on the far right or some other element of broadband technology, which is coming. And every time we do that that adds a little bit more content to the chip, a little bit more ASP to the chip and helps us fight the natural erosion that occurs in this market, relative to just price declines on new products.
On the upper part of the chart, what we try to do is show new markets and new opportunities, and one of the reasons why the broadband business grows sort of mid-to-high single-digits. Emerging markets are growing sort of low-to-mid double-digits, whether that’s in Brazil or Russia or China or India, your typical BRIC participants as well as other places as well, in Africa, etcetera. There is continued expansion of content around the globe to many of the markets that don’t have the content. And as the leading provider of silicon solutions to do that in cost efficient ways and recall that we make probably fairly large battleship chips. So, if you have one of these sort of genie receivers in your house that has five tuners in it, and a terabyte of space on the hard drive, etcetera, very large chip to much smaller chips like the thin ones you see on the sub-devices in your house that can be applied in developing markets.
In addition, there are other opportunities to expand our business. Typically, we have operated, we, as a company, with all of our engineering are very focused on driving integration and technology and integrating more and more things into the chip. Well, as you get to the point we have integrated most of the functionality in the chip and there are small slices of markets of slices of technology already have. There are opportunities now to cut those down with smaller chips and serve markets like outdoor units, DTAs, fiber access points which we had let other people have those small markets. And if you think about some of the smaller competitors in the broadband space that we compete with, you will notice that they are actually having a more and more difficult time, because we have chosen to actually begin to break apart some of our chips to pickup those elements to the market. And then you have sort of new things, things like Powerline Networking and femtocells which are showing up in peoples’ homes and we are participating in those markets as well.
Moving to the handset and the wireless space, the interesting thing about the handset people aren’t familiar with it is there is a lot of technology in those devices, and there is some presumption that certain parts of technology are harder or easier than others. And I think our competition did a very good job trying to explain to people that Wi-Fi was easy and that baseband was hard, although it’s interesting that it turns out that it’s been harder to do Wi-Fi than people thought. As you look at it, principally we have competed in handheld devices in a market, which is $3 to $6 depending on the content on that bottom part of the chart in connectivity, Wi-Fi, Bluetooth, GPS, NFC, etcetera.
And what most of our investments and one of the big drivers of the R&D spending we have been doing over the last couple of years is to position ourselves in the upper part of that, which is the opportunity to participate in the baseband and the application processor in an integrated format, principally on LTE. And I think what that does for us is it enables us to move upscale and up price points from about $3 to $6 in a device to anywhere between $10 to $30 in a device in a very, very large market. I think the market is probably north of $20 billion today.
Finally, on the infrastructure side, so about a $2 billion business on the infrastructure side as I mentioned this, you might think of this as the plumbing, the things that drive what’s in your wiring closet, data center, service providers, base stations, etcetera, and switch technology, the processor technology, some of the other technologies that serve those markets, highly profitable market, very attractive market. In 2011, the businesses we competed in were about a $4 billion SAM. And given the size of the market and the margin and the opportunity of the market, the single best thing we could do as a market leader was to expand our market. We broadened our market – we broadened our market footprint in that space. We added multi-core processors, network processors, KBP, microwave, digital front-end in addition to our switch 5 and controller business enabling us to expand the SAM from about $4 billion to $9 billion essentially take more position on the line card and leverage the cross-sell opportunities and the significant market share that the company already enjoys in its historic market. I think unfortunately that market has been a little bit sideways the last couple of years, hard to see, but I suspect as the market turns around you will begin to see more and more of the market share gains that we have got.
So, finally, I think, I have talked about the technology of the business. I have talked about the size of the company. I have talked about the innovation and relentless drive to integrate and competitiveness. The question is does it pay off right and does the investment in R&D and does the focus and competitiveness at number one in markets payoff. And I think the only way to really compare that as to look at a chart like this, which shows you in fact, over the time period, relative over the last 10 years relative to semiconductors, Broadcom has outperformed semiconductors by about 1,400 basis points, and let’s take out things that are principally memory and industrial on the slower growing pieces and focus on what really is our competition set, the com semiconductor space, and it’s 900 basis points, almost 10 points faster on a compound annual growth over a 10-year period of time.
For those of you who know us well and who have had the chance to read our proxy statement, in fact we actually payout our compensation and incentives based in part on this. We are measured on whether we outgrow our peer set and competitors by least 35%. Now, 35% over zero is nothing, so plus or minus 10 points for those of you who are math people in the room. It is actually full 3.5 points. So, we don’t achieve target unless we have outgrown our competitors by 3.5 points, or 35%, whichever is larger in an aggregate number of points perspective. That’s about 35% of our targeted payout. The second 35% is tied to profitability and operating margin. And the third piece, which is about a third or 30% is tied to a series of strategic objectives around core products and new technologies that we believe are critical to introduce to the market and drive our competitive position in the future that wouldn’t necessarily be measured in the current year.
So, with that, I will stop and I will take questions. Thank you.
Anil Doradla - William Blair
Very good. Thanks a lot, Eric. Maybe I will kick off with a couple of questions and then we will open it up to the audience. Well, given the fact that you are so well diversified – so well diversified you come across different markets across different geographies, we love to hear what you are seeing on demand environment, continues to be mix, we would love about your thoughts what you are seeing on the latest one?
Look, I would say we provided our guidance when we provide our guidance, we really we don’t update as a matter of policy I think that we don’t have any new information. Broadly speaking, I would say, there seemed to be and I read the same things you do some signs from our customers indicating they think that markets are getting better certainly on the infrastructure side, and I hope that that’s true and I would say we are cautiously optimistic, Much beyond that, it’s hard to – it’s really hard to call, I can’t tell you as a person who and remember I play defense, my boss plays offense, right. I can’t tell you yet that I actually believe the economy has turned around for a second.
Anil Doradla - William Blair
Good. The most topical theme in the Broadcom story is wireless, and that’s about half of your business. The vast majority of that is still driven by connectivity. There were many skeptics over the past several years that if the commodity and you would be replaced and you have proven them wrong, but the most exciting factor within that is your baseband business. Walk us through what the growth dynamics are, why are you winning, and over the next couple of years, how do you look at that business?
I think we are winning because of the same thing we win all the time, which is we provide an integrated solution that is either performs better or it’s cost effective than what exist on the market today. And I don’t think that’s any different in the baseband than it is in any other space. There are other factors that contribute the baseline effect. It’s interesting. Our wireless business last year on a segment grew about 9.5% if you were just for the decline of the business with Nokia, you could add 5 or 10 more points the growth of that, actually in terms of the impact that, that has the business.
I think the other reason is that the market wants to make sure that there is the second viable technology leader in the market to QUALCOMM. And we have customers making investments in us to do that. I think at various points in time, people thought it was different companies. I think people thought it was TI, I think people thought it was ST-Ericsson. Both of those companies have essentially exited the space and are not playing any longer and the market does need a second viable strong technology player to hold the price points where they should be in the market.
I mean, to give you a sense, how we are understanding is the price points on an LTE chipset, high-end LTE chipset is probably $40, $45 when in fact it probably should be close to $20 or $25, probably $25. And so those opportunities exist and I think you see that battle in 3G in China, and I suspect that, that battle will occur in LTE and to the extent that we can bring a viable leading edge LTE product, not only you get the benefit of having the viable LTE product, you also get the benefit of the drag through of all the rest of the products, because you become a broader supplier to these companies. A lot of the companies you are selling to, to a side right, Samsung and Apple who have vast resources, do not have the resources to support more than two vendors, and it’s challenging for them to do so. And they need to know that the people to whom they reported software to and built their code around and put their engineering resources on it, people that will be there at the long-haul and can provide them a product portfolio, which is competitive across their product line.
Anil Doradla - William Blair
Interesting. Now, when I look at your wireless business, I think that’s about 20% of your 50%, call it whatever high single-digits or low double-digits.
You mean, you are talking about selling….
Anil Doradla - William Blair
The baseline business, right. Now, you started that business sometime in I think ‘08 somewhere around that timeframe, you started off the 2G, 2.5G, but obviously there has been a transformation. Walk me through or walk us through what was the thinking of getting into 2G, 2.5G, not getting to 3G and it’s almost been as if you have been doing catch up and finally 2014, you are at par with the industry with 4G LTE?
I think there are interesting dynamics in our organization, when our organization decides to make an investment and there are business cases made, etcetera and actually happened just before I joined Broadcom in ‘07 and it happened probably in ‘06. And as with everything, the people underestimate the time and the cost associated with doing it, when I joined Broadcom, I asked people how long does it take to get to critical mass in a market if you decide to get into a market today, and the vast majority of the engineering leadership and general manager said three years. And you go back and you do the analysis and you discover that actually – while the mean or median is 4, the more complex the chips are, the more it looks like 5 or 6. And so if you build a business plan that looks like 3 and it’s going to take 5 or 6, and all of a sudden you are into it a couple of years and you realize the revenue isn’t showing up. What do you do? You invested to the quickest revenue to sustain the investment and the business to prove that you have got some traction.
Now, I am not saying that’s exactly what happened, but it’s not terribly far off to be perfectly honest, I think we made a decision when we are making the investment and certainly in 2007, when the economics of the company were relatively tightening R&D, investment choices were relatively tight. There was a new CFO who said that you needed to be portfolio-based as opposed to just spending on everything, it looked interesting. And as a result, we made a decision to go after what was the fat part of the market at the time not recognizing or recognizing, but perhaps closing our eye to the fact that we were chasing after something that was moving. And when we aimed it, we aimed the gun where the duck was, as the duck continued to move, we ran up shooting behind the duck. I think, there are two strategic – there are two pieces to this. One is a strategic error that we probably shouldn’t have made, and one strategic error that you could not have predicted. We hunt elephants. We don’t go after a little people. And so we decided to go after Nokia, who at the time was the dominant handset provider in the space, nobody had even heard of Apple. Samsung was interesting, but they were following Nokia, and everybody said oh my god, I cannot believe you are choosing to choose Nokia, and we did and we won Nokia and we all know what the story with Nokia is.
So, on that part, you could not – you can’t in hindsight have made a different decision and you wouldn’t have seen or known what the iPhone was going to be at that point in time. If you had even seen what it was, because in most cases when you deal with Apple and you are discussing text specs with a sheet over something. So, you don’t even know what it is. It’s one of those things where one strategically that we should have known as we should not have gone behind in technology. That’s not something Broadcom has ever done, but because the market was so large, the investment was taking longer. I think the general management at that point in time felt that they needed to vector into the market and prove real tangible results to get the kind of investment to pursue the future technologies. And the second one was nobody could have predicted what happened to Nokia.
Anil Doradla - William Blair
Very good. And that leads me to the future, 2013 to 2014, would you characterize the next 12 to 18 months being kind of an inflection point in your baseline business. You feel that 2014 you are going to be at par with some of the leaders out there?
I certainly think it’s a technical inflection point. And I think that it’s one of those points where you are making significant investment and trying to prove that you can deliver a product that really nobody other than Qualcomm has announced that they would have, they don’t currently have. And we need to deliver that product and we need to prove that we can deliver that product faster than other people and hopefully in some form or fashion either power or performance that actually is better than what’s currently or what will be on the market. And I do think ‘13 and ‘14 will be very important years for the company, excuse me, yes, ‘13 and ‘14 will be very important years to prove that point and establish ourselves in the market, and after that, I think we are off to the races.
Anil Doradla - William Blair
And for many investors when I talk, their focus is on 3G, there is a degree of confidence of your success there, but everyone are focused on the 4G product line, which you have talked about sometime in 2014, how is that coming by?
Well, I mean, I understand why. I mean, the truth of the matter is again, those that follow us, many people in this industry announce products while they are still slideware. You will note that we don’t typically announce products until they are sampling as we announced this morning and yesterday. Yesterday with our new multi-core processor, which we believe will be best-in-class and with our new quad core high-end 3G chip that we announced this morning. Look, I think that it proves in the putting. We have done our best to try to give you the signpost. We have done something we don’t normally do at Analyst Day and show the thin modem version of our LTE chip before it was actually sampling, but we wouldn’t normally do that and we did that only because we felt it was very important for investors to know what the milestones and the fact that we are making progress. I think you could assume that we are going to sort of hang tight and you will hear more from us as those products are actually sampling and really in customers’ hands of getting ready to be put into devices.
Anil Doradla - William Blair
Great, then, at this stage, I will open up.
They are already in smartphones. I think you will see it ramp, I think in handsets, certainly in the high-end handsets, mid double-digits by the end of the year. I don’t mean cumulatively I think by the end of the year is what you will see, a large number of the new leading (indiscernible) RAC phones.
Yes, in combo chips, it’s kind of a saw tooth. So, there are periods of time of innovation where price point goes up and there are periods of time where die size shrinks. And a great example is 2012. 2012 is sort of, what I will call, the downside of the saw tooth. And the reason why it’s the downside of saw tooth is the transition, the final transition from 4329, which is the first generation end part to 4330 and then ultimately 4334. So, 4329 is sort of on the last legs, but 30 was sort of the heart. What was going into the year and 34 is the new chip. The die size shrink between 29 and 34 is about 60%. And so with that die size shrink and our customers are smartly understand that, that means there is a lower cost associated with it, and we passed along some of the lower cost associated with it. So, you will see an ASP decline and you can see actually in our named customers, one of which we principally shift connectivity that the growth rate of that customer does not match the growth rate of what you would expect in devices, and that’s principally due to the price reduction you see associated with the transition across chips.
With the advent of AC and 2x2 and dual stream, dual band, sorry, dual band, you are seeing an up-tick in price, and I would say double-digit up-tick as a percentage in price. So, what does that mean the chip goes from $3 to $4 or $4 to $5, it can go up, and then it will run its saw tooth back down for the next innovation, which could be the addition of NFC and a quad-combo, could be the next advent of wireless LAN, which I think will be very important, which will be super high data rate, 60-gig version of wireless LAN and then longer range wireless LAN. Currently, with beam-forming technology on a 3x3 AC chip, unobstructed you can get about 7 megabits per second, at about half a kilometer. There are new standards which will up that up into the 100s of megabits per second, which will change the nature of which you are able to receive data on a device at very high speeds, outdoors, and in a city. It won’t work obviously in a rural location it will be principally rely on the baseband. And as we all know, the service providers really want this to happen just based on the actual cost and network management issues associated with not doing that.
Anil Doradla - William Blair
I think we have time for one more question. Okay, now Eric, when I look at your connectivity solutions, I mean, it’s done phenomenally well, and time and again the barriers have proven to be wrong about you getting displaced multiple people getting in. There is that concern, there continues to be that concern. Can you explain where investors misunderstand the story? What is the biggest misperception of that part of your business?
Yes, look, again I think it’s something I mentioned when I was presenting. I think the general belief amongst the investment community is that Wi-Fi is easy and basebands are hard. Those are hard. And what’s hard about combo chips is the fact that you are running multiple radios, multiple standards on the same piece of silicon nanometers apart from each other. And as a result, the interoperability, the co-existence of those parts become very, very difficult to manage and the performance range, power consumption, integrated functionality, the bomb benefit to the customer, if you don’t continue you innovate, you don’t continue to win. So, I think what happened to our competition is like what happened to us in the baseband as they have been shooting behind what we are doing. The difference here is we don’t tell people what we are doing frequently in connectivity until we are actually physically shipping it.
Anil Doradla - William Blair
Very good. And with that we will go into the breakout room. Thank you very much, Eric.
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