Broadcom (NASDAQ:BRCM) announced a mixed set of Q4 2013 results on January 30th, as revenues exceeded the high-end of guidance but gross margins fell due to increased price competition in the 3G chipset market and higher-than-expected levels of excess and obsolete inventory. Total inventory was relatively flat year to year. The company reported Q4 revenues of about $2.06 billion, which was lower than the year-ago levels by about 0.8% but slightly ahead of the projected revenue range of $2-$2.05 billion. The top-line outperformance was mostly driven by a better-than-expected quarter for its infrastructure sales, which grew by about 2% sequentially on strong demand for Ethernet switches among service providers and enterprises, as well as within data centers. On the other hand, Broadcom’s home broadband and mobile connectivity divisions, which account for almost three-fourths of its overall revenues, posted a combined sequential decline of almost 6% in revenues – in line with company expectations.
The higher mix of infrastructure sales, which carry higher gross margins than the company average, ought to have improved the company’s overall margin profile. But delays in launching 4G LTE chipsets left Broadcom more vulnerable to the increased pricing pressure that the low-end 3G market is facing currently, which more than offset the impact of the improved mix. As a result, Broadcom’s non-GAAP gross margins declined by about 100 basis points to 52.6% last quarter. Going forward, we expect Broadcom to leverage its recently completed Renesas deal to significantly accelerate the go-to-market of its LTE chipsets, and stem the margin decline. At the same time, continued momentum in the data center, where Broadcom is extremely bullish about the prospects of its Trident II switch, as well as technology transitions toward 5G Wi-Fi and ultra-HD content should help the company drive its revenue growth in 2014 and beyond. 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.
Broadcom Will Look To Increase LTE Mix Within Chipset Sales
Broadcom’s mobile division accounts for almost half of its overall revenues and about 40% of its total value, by our estimates. The company derives most of the revenues in this division from the sale of wireless connectivity solutions, which includes Wi-Fi, Bluetooth and near field communication (NFC) solutions. The company has a market-leading 33% share in this segment, by our estimates, and we expect it hold on to its position in the coming years as newer technologies such as 5G Wi-Fi and 2×2 MIMO gain wider adoption. However, while Broadcom’s connectivity solutions may find wide acceptance at the high-end of the smartphone market in phones such as the iPhone, its market share at the low end is not as strong.
It is therefore of some concern to Broadcom that the high-end smartphones sales in developed markets seem to have hit a wall, with wireless carriers such as Verizon and AT&T in the U.S. looking to moderate their subsidy spend and boost margins. Last quarter, Verizon and AT&T reported a combined decline of almost 17% in their smartphone activations over the same period last year. The impact could be easily gleaned from Apple’s holiday-quarter results, which showed its North American sales contracting by 1% year on year. As a result, we see most of the future smartphone growth coming from emerging markets such as China and India, where 3G/4G penetration is still very low and carriers are intent on driving data usage through smartphones. According to IDC, more than 210 million smartphones were sold in China in 2012, giving the country a share of almost 30% of the world market. That figure is expected to have exceeded 350 million in 2013, with the country’s share increasing to around 35%. 
Broadcom is therefore looking to further its market share in China by forging relationships with carriers and working with them to launch new low-and mid-end smartphones. However, the increasing mix of emerging market sales could pressure Broadcom’s chipset ASPs (Average selling prices) as well as margins. The company is looking to offset the impact by foraying into 4G LTE chipsets, which should help it secure some high-end wins. Currently, the company ships mostly 3G chipsets, where it is seeing some tough price competition and sharp margin declines as a result. However, the company recently closed the acquisition of LTE-related assets of Renesas Electronics, which has given it 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 expects its LTE-chipset business to be small in the first quarter, but ramp significantly towards the back half of the year. We expect Broadcom’s increasing focus on China and the country’s transition to 4G LTE to play a key role in it gaining a more significant share of the cellular baseband market in the coming years.
Strong Growth In Data Center and LTE Infrastructure
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, with Q4 marking the high point for infrastructure sales. Data center remains a strong growth driver for the company, with Broadcom’s leadership in high density Ethernet switches a key driver. The company saw its data center business in Q4 increase 50% over the same period last year, and the full-year growth was about 25%. 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.
On the service provider side as well, we expect the company to benefit from the ongoing transition to 4G LTE in China, where it has secured wins for switches, processors, the back haul and other technologies. Currently, only China Mobile is aggressively building out its TD-LTE network but we expect the other carriers to join the fray soon as FDD-LTE licenses are rolled out in the coming years.
Leadership In Set-Top Boxes To Drive The Broadband Business
Although Broadcom’s access business declined sequentially in Q4 2013, we expect the company to increasingly benefit from the transition to ultra HD content and HEVC-enabled set-top boxes in the coming years. This will be especially important in the developed markets where operators are showing strong interest in the new HEVC compression format, which nearly doubles the bandwidth capacity of current networks and allows for the transmission of more ultra-HD content. Together with the fast-declining prices of ultra-HD TVs, this means that the adoption of the new technology is likely to grow quickly in the coming years. In 2012, Broadcom shared the top spot in the worldwide set-top box integrated circuit market with STMicroelectronics. However, while both companies shipped between 85-86 million video SoCs for set-top boxes during the year, Broadcom earned higher revenues as it accounted for significantly larger-value design wins in developed regions such as North America and West Europe.
In emerging markets, the company is broadening its footprint by bringing more carriers under its fold while it continues to benefit from the increasing penetration of pay TV households in these 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.
- China’s Smartphone Shipments to Exceed 450 Million by 2014, IDC, September, 2013
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