In an earlier article, I argued that Marvell's (MRVL) TD Innovation will drive double digit growth. During the third quarter, however, gross margins declined for the fourth consecutive quarter and HDD continued to show softness in Networking. At the same time, management is rightly diversifying in wireless and introducing products to maximize gains from the smartphone and the tablet craze. Sequential growth of 24% in mobile and wireless in the third quarter accelerated from 18% last quarter.
At the third quarter earnings call, Marvell's CEO, Sehat Sutardja, noted such improvement:
Today, we reported third quarter revenues of approximately $950 million reflecting a 6% sequential increase from the prior quarter driven by our mobile and wireless end market. We delivered the following non-GAAP results: gross margin of 56.8%; operating margin of 25%; and earnings per share of $0.40. We generated free cash flow of approximately $239 million, equivalent to a 25% free cash flow margin. In addition and consistent with our plan to return value to our shareholders, we continue to repurchase our shares. In Q3, we repurchased about 50 million shares for a total of approximately $215 million.
Now let me summarize our results across our end markets. First, in our mobile and wireless end market, Q3 revenues increased approximately 24% sequentially and represented about 31% of our overall revenues. Growth in this end market was better than our initial expectations with the sequential increase driven by strong growth from our new products that goes into TD-SCDMA smartphones and seasonal growth from our wireless connectivity solutions.
Since the time I published the article, a major market development has presented itself that drives my attention away from the company. While Marvell turned out to be relatively flat since I published my article, its competitor, Broadcom (BRCM), fell by 18.9% while the Dow Jones went up 6.9%. Accordingly, I believe investors can benefit from this differential being closed.
The near future may be challenging for Broadcom due to macro headwinds and lower demand for technology, but the company is extraordinarily positioned to innovate WiFi and experience market share gains in Ethernet switching/controller for 2012. As the inventory levels correct, Broadcom is also likely to excel in LTE with its low cost and quality offerings.
Consensus estimates for Broadcom's EPS are that it will grow by 2.6% to $2.79 in 2011, decline by 3.9% in 2012, and then increase by 12.3% in 2013. Assuming a multiple of 18x and a conservative 2012 EPS estimate of $2.55, the rough intrinsic value of the stock is $45.90 for a staggering 51.5% upside. Even if the multiple plummets to 13x and EPS turns out to be 8.6% below the consensus at $2.45, there is no downside by this calculation. Accordingly, I agree with the "strong buy" rating on the Street.
Marvell, on the other hand, has the dominant position in TD smartphone solutions. TD more than doubled from the second quarter. In addition, China Mobile is investing in TD-SCDMA and TD-LTE, as the semiconductors firm receives orders from major tech customers.
Consensus estimates for Marvell's EPS are that it will decline by 21.3% to $1.29 in 2012, decline by 1.6% in 2013, and then turnaround to increase by 33.9% in 2014. If the multiple falls to 11x and 2013 EPS turns out to be 13.4% below the consensus at $1.10, the stock has 15.3% downside. This lower bear case than the one for Broadcom makes me believe that the latter has more favorable risk/reward.