Broadcom's Revenue To Decline In Q4'13, But Long-Term Prospects Remain Bright

| About: Broadcom Limited (AVGO)

Leading semiconductor provider for wired and wireless communications, Broadcom (BRCM), will report its Q4 2013 and full year earnings on January 30. Broadcom’s growth has slowed over the past couple of quarters as it faces intense competition in the connectivity domain and invests to build its baseband portfolio. It reported a 0.8% year-over-year growth in its top-line and witnessed a 1.4% annual increase in gross margin in Q3 2014, as it benefited from a stronger than expected mix and a decline in its excess and obsolete inventory.

Earlier last month, Broadcom increased its projected revenue range for Q4 2013 from $1.79-$1.98 billion to $2-$2.05 billion due to better than expected sales across all business segments, particularly Infrastructure and Networking. Additionally, the company lowered the upper limit of the estimated rate of decline in its gross margin (GAAP and non-GAAP) from 1% to 0.75%. However, despite the revised guidance, Broadcom expects to see a sequential decline in all its business segments – baseband, broadband and networking – in Q4 2013.

Nevertheless, Broadcom believes its growth will accelerate in 2014 backed by the LTE certification of its mobile devices, continued strength in the data center, as well as rising 5G Wi-Fi and other multiple technology transitions. Our price estimate of $38 for Broadcom is at a significant premium to the current market price of $29 and we continue to believe in the company’s long term growth potential.

We will update our valuation after the Q4 2014 earnings release.

LTE Certification To Expand Presence In The Baseband Market

In 2013, Broadcom announced its first LTE-compatible baseband chip, which it claims to be 35% smaller compared to current products. This makes it the industry’s smallest 4G LTE chip in the market. Initially, Broadcom did not anticipate any significant revenues before the second half of 2014. Investors expected the chip would start production much earlier than that and we think that this was one of the main reasons for the significant decline in Broadcom’s stock price between July and August 2013.

However, in October 2013, Broadcom closed its acquisition of the LTE-related assets of Japanese chipmaker Renesas Electronics (OTCPK:RNECF). The deal gives Broadcom access to a dual-core LTE SoC that is ready for volume production and is carrier-validated by leading global operators in North America, Japan and Europe. Broadcom claims that the acquisition of LTE-assets from Renesas will help it accelerate the production of its first multimode, carrier-validated LTE SoC platform into early 2014.

Broadcom does not have a very large customer base for its 3G business and accounts for only 3% of the mobile baseband and application processor market. However, we believe the LTE certification will help expand the company’s foothold in the baseband market. Of the various technologies that are driving the market currently, LTE is seeing the strongest growth, as carriers around the world increasingly shift to the new standard for wireless communication.

Strong Growth In Infrastructure & Networking

On account of reduced data center and enterprise spending, as well as lower service provider capital expenditures, Broadcom marked a 10% decline in its Infrastructure and Network revenue in 2012. However, the company witnessed continuous growth in the segment in 2013. Data center remains a strong growth driver for the company, with Broadcom’s leadership in high density Ethernet switches a key driver. Its next generation Trident II is now in volume production and Broadcom expects the same to contribute to its growth momentum in networking through 2014.

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.

Leadership In Set-Top Boxes To Drive The Broadband Business

Driven principally by weakness in its access business, Broadcom expects its Broadband business to decline sequentially in Q4 2013. However, it believes that the set-top market continues to be a key growth driver for the company. Driven primarily by rising demand from emerging markets, the global set-top box shipments are forecast to grow at a CAGR of 9.7% through 2016.

Broadcom shared the top spot in the worldwide set-top box integrated circuit (IC) market with STMicroelectronics in 2012. While both companies shipped between 85-86 million video SoCs for set-top boxes last year, Broadcom earned higher revenues as it accounted for significantly larger value design wins within the North American and Western European cable and satellite markets.

Broadcom has been continuously innovating its product portfolio to expand its footprint in the rapidly expanding low-cost set-top box market. It claims to be increasing the penetration of its products across the BRIC countries in 2013. With a focus on innovation and the addition of entry-level systems to its portfolio, the company is in a strong position to retain its leadership in the global set-top box market, in our view.