Broadcom (BRCM) reported its Q2 2014 earnings on July 22, as we noted in our recent post view. Today we are going to take a deeper look at future trends. At $2.04 billion, revenue was near the midpoint of company guidance, and increased 2.9% annually but declined 2.3% sequentially on account of diminishing revenue from the baseband business. Non-GAAP EPS came in at $0.65, above first call estimate of $0.61.
Last month, Broadcom announced its decision to exit the cellular baseband business on account of intense competition in the market. (Read: Rising Competition Forces Broadcom To Exit The Baseband Market) The company intends to instead increase its focus and competitiveness in the broadband, infrastructure and connectivity businesses. Broadcom performed well in all the three segments in Q2 2014 and expects to see strong growth from these markets in the future as well. It believes that its decision to exit the baseband business puts it on a path toward being a stronger, more profitable company that can return more capital to shareholders.
Our price estimate of $38.49 for Broadcom is in line with the current market price.
Despite The Baseband Exit The Connectivity Business Remains Strong
Following its exit from the baseband market, Broadcom incurred losses in some paired connectivity-baseband products in Q2 2014 and expects to see some continued erosion in the low- to mid-range platforms as well. Nevertheless, the company believes that its leadership in connectivity solutions remains intact. It has some new technologies ramping and is seeing higher ASPs for its products due to additional functionality for some customers. Additionally, Broadcom sees new growth potential in the markets for the Internet-of-Things, as well as automotive and wearable electronics. It continues to drive leading-edge features inorder to maintain its strength in high end smartphones and tablets, and is strengthening and diversifying its portfolio with new low power connectivity solutions for the Internet of Things and the support of iBeacon and HomeKit.
Broadcom expects to see strong sequential growth in connectivity solutions over the year driven by product cycles and some launches from key customers. It derives close to 50% of its revenue from the wireless segment and we estimate that 75% of the contribution comes from the connectivity solutions market.
Data Center Growth and LTE Build-Outs To Drive Growth In Infrastructure
At $635 million, Broadcom's infrastructure and networking revenue came in ahead of expectations and was up 10% sequentially and 24% annually, in Q2 2014. Growth in the quarter was mainly driven by Ethernet switching, particularly in the data center and service provider markets. 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. Infrastructure strength over the course of the year, so far, was about two-thirds data center driven and one-third service provider driven.
Broadcom continues to deliver innovative solutions that set the stage for an industry transition to more virtualized scalable data center architectures. Its next generation Trident II is now in volume production and it expects the same to contribute to its growth momentum in networking through 2014. During Q2 2014, in partnership with with other cloud market leaders, Broadcom announced a new 25-gig and 50-gig Ethernet specification to drive performance and cost efficiency in data centers.
We expect Broadcom to benefit from the ongoing transition to 4G LTE in China where it has secured wins for switches, processors, 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 soon as FDD-LTE licenses are rolled out in the coming years. Broadcom has seen double digit growth in this segment over the last three years and it believes that the additional waves of LTE buildouts, especially in China, will be helpful to sustain that growth for the next few years.
Broadband Business To Be Driven By The Set-Top Market and Access Business
Broadcom's broadband communications revenue ($625 million) also beat company expectations, growing 12% sequentially and 10% annually with growth across the board. Growth in the segment is being driven by the set-top boxes and broadband access businesses.
The set-top box group continues to perform well, delivering 8% sequential growth in Q2 2014, and is a key growth driver for the broadband business. Broadcom claims that in the first half of 2014 it gained share in international markets on account of rising digital penetration and a ramp to richer features, including multi-stream transcoding, more tuners and a stronger mix of MoCA-enabled platforms. Driven primarily by rising demand from emerging markets, global set-top box shipments are forecast to grow at a CAGR of 9.7% through 2016.
Another long-term growth driver for the set-top box market is the transition to HEVC and Ultra HD. This month, Broadcom powered live Ultra HD broadcasts of 2014 World Cup events, in partnership with Sagemcom, Oi and NETServicos. Broadcom claims that the industry is still in the early transition (to Ultra HD) phase and sees this strength as a powerful product cycle that will contribute growth over the coming years. Broadcom is one of the leading players in the worldwide set-top box integrated circuit (IC) market.
In the broadband access business, Broadcom's modem sales reached a multi-year high in Q2 2014, increasing over 15% year on year, with growth across cable, DSL and PON. The company is seeing strong momentum in its VDSL and PON sales due to share gains, increased operator spending and new operator service launches. Its access business is growing as operators continue to deploy the latest technologies, including VDSL upgrades, to power faster connections in the home. Broadcom claims to be gaining share in PON and sees new product cycles coming in Broadband Access.
Disclosure: No positions.