Why Broadcom Is Heading To $35

| About: Broadcom Limited (AVGO)


The company's struggle has been industry-wide and it doesn't reflect on Broadcom's management team.

At around $30 per share, I believe Broadcom offers compelling value and minimal downside risk.

The stock remains inexpensive on an absolute basis at 11-times forward consensus earnings.

Semiconductor giant Broadcom (BRCM) will report first-quarter earnings results on Tuesday. With ongoing fears about the company's weak mobile/wireless business, which is being threatened by (among others) Qualcomm (NASDAQ:QCOM), Broadcom management needs to assure investors that this business is still viable.

When compared to Qualcomm, which is the market leader, Broadcom's results have disappointed. But I don't believe they have been as bad as some analysts have proclaimed. Rather, Broadcom has fallen victim to its own success. The company's strong historical performances, by virtue of its relationship with both Apple (NASDAQ:AAPL) and Samsung (OTC:SSNLF), has commanded high expectations.

The problem, though, given the "upper-tier level" chip position that Broadcom has enjoyed when compared to, say, Advanced Micro Devices (NYSE:AMD), Broadcom has been unable to avert high-end device saturation and low average selling prices (ASP). I don't blame investors for cashing in their chips and running to the next story, but let's acknowledge that the struggle has been industry-wide and it doesn't reflect on the company's management.

On Tuesday, none of this will matter. Although management has been making the best of a bad situation, Broadcom will need to deliver a "trifecta." This means not only does Broadcom need to beat on both revenue and profits, but guidance has to suggest that investors' worst fears are over.

The Street will be looking for 46 cents in earnings per share on revenue of $1.96 billion, which assumes a 6% sequential decline. Management's guidance was $1.9 billion to 2.0 billion. But that's not where the focus should be. Given the fiercely competitive landscape of the mobile industry, the stock should hold up pretty well if management can show that Broadcom is keeping up Qualcomm in areas like integrated 4G mobile solutions.

And if the numbers show that Broadcom has not suffered drastic declines in Mobile & Wireless revenue, this, too, would be a monumental victory. By "drastic," I mean anything more than 10% sequential decline. Consider, normal seasonality decline stands at mid-single digits. Despite the expected declines, I remain bullish because Broadcom is more than a chip company.

Consider, although Broadcom's mobile/wireless business generate the lion share of the press, some still take for granted that Broadcom has a meaningful presence in the realm of networking, where one of its biggest customers includes Cisco (NASDAQ:CSCO). Not to mention, the company also generates revenue from satellite and voice-over-IP (VOIP) components.

Given this advantage, I'm looking for potential upside in the Infrastructure & Networking segment, where Broadcom trends have improved over the last several quarters. From my vantage point, Broadcom should benefit from favorable gross margin mix, which I believe presents meaningful upside to the company's non-GAAP gross margin. Although management guided for a 50 to 100 basis-point decline, I'm projecting a modest beat by one penny above consensus estimates of 46 cents per share.

Investors also shouldn't discount the potential effect of Broadcom's deal last year for LTE-related assets from affiliates of Renesas Electronics Corporation, which the company acquired for $164 million. Essentially, Broadcom is gaining assets that are industry-tested and ready for volume production today. Not to mention, these included dual-core LTE SoC (system-on chips).

What this means is that, although Qualcomm's Snapdragon S4 continues to be the most widely used chip on the market, Broadcom's no longer just "chopped liver." And management demonstrated strong confidence that it can harvest value from this transaction.

All told, given the company's breadth of capabilities, I would be a buyer here ahead of Broadcom's earnings report. I'm not suggesting that Broadcom will immediately overtake Qualcomm's market lead. But the company should be able to outperform not only its near-term estimates, but those that are several quarters ahead.

At around $30 per share, I believe Broadcom offers compelling value and minimal downside risk. The stock remains inexpensive on an absolute basis at 11-times forward consensus earnings. This is a slight discount to the historical average of 13 times estimates, which places shares right around $35 in the next 6 to 12 months.

Disclosure: I am long AAPL.

Business relationship disclosure: The article has been written by Wall Street Playbook's tech sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.