Broadcom: Moving Forward And Overcoming Distractions

Feb.29.12 | About: Broadcom Limited (AVGO)

Chip giant Broadcom (BRCM) has been on a steady climb since the beginning of the year. With the stock having gained as much as 30% since the end of December, it seems that the company has caught the attention of Wall Street. However, on Friday the company informed shareholders that it had also caught the attention of the Securities and Exchange Commission. Broadcom announced that the SEC is conducting a formal investigation of the company's accounting practices relating to how much it has claimed as reserves for litigation. And the SEC will be looking as far back as June 1, 2010.

The company said it thinks the investigation was prompted by claims on the part of a former employee. Broadcom said its own inquiry into the matter had found nothing amiss:

The company, with oversight from the audit committee of the board of directors, completed an internal review of these allegations with the assistance of independent outside counsel and did not identify any improprieties. In addition, based on the internal review, the results of which were discussed with the company's independent registered public accounting firm, the company determined that no adjustments to its fiscal 2010 and March 31, 2011, consolidated financial statements were necessary relating to the subject matter of the review. The company is cooperating with the SEC's investigation.

Upon the announcement, shares of the company were down as much as 3% to $35.65 in extended hours trading. It is too early to say what will become of this investigation. However, if you take the company at its word there is likely nothing to be worried about. However, one can never know with these things and investors will just have to wait patiently for the process to work itself out.

All of that notwithstanding, I continue to be enamored with the company as part of my recent love affair with the semiconductor sector. Again, the fact that Broadcom and other chips have close ties with Apple (NASDAQ:AAPL) it makes them that much more appealing. But whatever the reason is, the company still deserves a look for its own merits - even with the fact that it has already climbed 30% on the year, it remains one of the very few with room yet to grow.

Recently, the company reported Q4 and 2011 earnings that topped Wall Street estimates. It earned an adjusted profit of 68 cents a share, on revenue of $1.82 billion. Analysts had expected 64 cents per share, on revenue of $1.81 billion, according to a consensus survey by FactSet Research. To add more excitement to the call, the company issued sales outlook for the current quarter that also topped what analysts had projected. JPMorgan analyst Harlan Sur said in a note:

"Although management was reluctant to call a bottom in the first quarter, we believe there are enough areas of strength in the form of new product and program ramps that should enable Broadcom to drive growth in the second quarter and into the second half of the year."

The company's earnings as well as optimistic outlook is an impressive sign that the semiconductors are indeed on a rebound considering how weak margins have been within the entire sector, which includes names such as Qualcomm (NASDAQ:QCOM) as well as Texas Instruments (NASDAQ:TXN). But as with all three companies, the link to Apple may serve as enough of a growth driver for the next several quarters and likely the rest of the year. In particular, of the revenue that Broadcom generates Apple accounts for over 10% of that figure by the fact that it uses the company's chips in all of its products on the market.

Outlook for 2012

For Broadcom, as great as the outlook appears for the coming year when discussing its growth potential in smart phones and devices, there is another area in which it competes that is also due for a rebound. In following Cisco (NASDAQ:CSCO) as much as I have, it should be noted that Broadcom is a formidable rival in the routing and switching space. An area that has been down of late due to weak technology spending, but once it fully rebounds, the company's ability to steal market share should not be underestimated.

It seems several Wall Street analysts already agree, with its highest target being $55. The question is, with so much coverage on the stock and with positive expectations, how much more good news can there be? In other words, with the stock up already 27% on the year, has all the good news been priced in? I am not ready to declare that to be the case at all. As Apple's sales continue to grow, as well as the sales from other names, such as Google (NASDAQ:GOOG), it stands to reason that Broadcom's revenue should rise to commensurate the sales figures of the devices.

Summary

I can't deny that with a P/E of 22, the stock is not cheap - not by any stretch. Particularly compared to peers such as Texas Instruments and Nvidia (NASDAQ:NVDA), whereas it is on par with Qualcomm. The level of competition will be perceived as a risk for those considering Broadcom. But this is nothing new and a concern the company can easily navigate as evident by its recent earnings and stellar outlook. Value investors who are willing to be patient should give this company a long look and expect shares to approach $50 by year's end.

Disclosure: I am long AAPL, CSCO, TXN, QCOM.