Leading semiconductor provider for wired and wireless communications Broadcom (BRCM) reported its Q1 2014 earnings on April 24. At $1.98 billion, revenue was at the upper end of Broadcom’s guided range as well as above the consensus estimate; it declined 4% sequentially and 1% year to year. Broadcom witnessed strong growth in its broadband and infrastructure business segments, which was more than offset by a decline in its connectivity business. Gross margin declined from 50.7% in Q1 2013 to 49.4% in Q1 2014 primarily due to an unfavorable product mix.
We believe that Broadcom performed well in a seasonally down quarter. The company expects its growth to 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. It anticipates revenue will increase by 3% (at the mid-point of its guided range) in Q2 2014, driven by continued strength in its broadband and infrastructure business. Broadcom expects its wireless business to decline in Q2 2014 but indicates that the business will grow in the second half of the year. Additionally, the company believes that a favorable mix and improvements in certain non-standard, non-recurring costs will help improve its gross margin in Q2 2014.
Our price estimate of $38 for Broadcom is at a significant premium to the current market price. We are in the process of updating our valuation for the company.
Mobile Business To Grow In The Second Half Of 2014
Broadcom’s mobile and wireless revenue declined approximately 10% sequentially in Q1 2014, which was in line with seasonal trends. Broadcom’s mobile and wireless business can be split into two parts: connectivity solutions and baseband solutions. With a 33% market share, Broadcom has been the leader in connectivity solutions for many years and, despite losing some low-cost smartphone sockets to Qualcomm (NASDAQ:QCOM), Broadcom claims that its market share in the segment remains stable.
On the other hand, Broadcom accounts for only 3% of the mobile baseband and application processor market. The company announced its first LTE-compatible baseband chip in 2013. Broadcom recently closed the acquisition of the LTE-related assets of Renesas Electronics (OTCPK:RNECF), which helped speed up the launch of its 4G LTE chips by giving the company access to a dual-core LTE SoC that was ready for volume production and is carrier-validated by leading global operators in North America, Japan and Europe. In Q1 2013, Broadcom shipped its dual core LTE SoC and claims to be engaged in talks with various customers, which should translate into multiple design wins later this year. Its 4G business is tracking its road-map milestones.
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.
Data Center Growth & LTE Build-outs Drive Growth In The Infrastructure Segment
At $579 million, Broadcom’s infrastructure and networking revenue was above the company’s expectation and grew 1% sequentially and 35% year to year. Strength in the quarter was driven by continued growth in Broadcom’s switching business, particularly in the service provider and data center markets. It continued to see strong demand from service providers for a broad range of switch and processor solutions that power base stations, back haul and the core of the network. The service provider market growth was mainly driven by LTE build-outs in China, while data center growth was driven by the transition to public cloud and broad adoption of Broadcom’s leading merchant platforms.
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 (NYSE:CHL) 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.
Broadcom continues to deliver innovative solutions that set the stage for an industry transition to more virtualized scalable data center architectures. Data center remains a strong growth driver for the company with Broadcom’s leadership in high density Ethernet switches. 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.
Broadband Business To Be Driven By The Set-Top Market & Access Business
Broadcom’s broadband communications segment reported a 2% sequential growth, which was above company guidance, driven by stronger than expected sales of both set top box and broadband modem solutions.
The access business grew in the quarter as operators continued to deploy the latest technologies including VDSL upgrades to power faster connections in the home. Broadcom is seeing strong momentum in its VDSL and PON sales due to share gains, increased operator spending and new operator service launches. Also, it gained share in PON globally and saw continued unit growth driven principally by China
The set-top market is another important growth driver for Broadcom. 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 claims that in Q1 2014 it gained share in international markets on account of rising digital penetration and new designs, which came to market in Russia, Europe, Central and South America. In developed countries, the industry is transitioning to ultra HD along with HEVC, which will drive richer content in the set top box for years to come, a trend that will benefit Broadcom.
Q2 2014 Outlook
- Revenue in the range of $2 billion to $2.1 billion. Broadband and infrastructure to be up and mobile and wireless to be down slightly.
- Non-GAAP and GAAP product gross margin to be up 0.75% – 1.75% and 1% – 2%, respectively.
- Global Research of Set-Top Boxes Market – Global Industry Size, Market Share, Trends, Analysis and Forecasts 2012-2018, SB Wire, March 15, 2013
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