Reporting record quarterly revenues of $2.13 billion and strong cash flow of $621 million, Broadcom (BRCM) posted a stellar Q3 2012 on October 23. The company saw strong growth in all three businesses – Connectivity & Baseband, Network Solutions and Broadband – with the mobile and wireless segment posting the fastest growth on strong demand for connectivity solutions. Additionally, due to a decrease in inventory step-up, GAAP gross margins saw a slight increase this quarter.
Historically, Q3 has been the strongest quarter for Broadcom as its customers build up inventory to meet the demand during the holiday season. The company estimates revenue for Q4 to be in the $1.95 – $2.1 billion range, which translates to a decline of 8% to 1%. We believe the estimated deceleration in growth is more a seasonal factor than a long-term trend.
We expect Broadcom to register a significant decline in its top-line growth this year on account of macro headwinds. However, keeping in mind the robust product road-map and accelerating design wins by the company, we forecast a higher growth rate 2013 onwards.
Here we highlight certain key trends and concerns prominent in the company’s Q1 2013 earnings results.
Increasing Share In China & Seasonality In Connectivity Business
Broadcom reported record earnings of $1.02 billion from its mobile and wireless division, primarily on account of solid growth in wireless connectivity, which grew faster than the overall mobile and wireless business. The majority of the upside in Q3 was driven by Broadcom’s customers stocking up inventories ahead of the upcoming holiday season; hence the company anticipates a slight decline in revenue this quarter.
Much of the growth in connectivity was driven by share gains in China as well as an improved product mix. China remains an important destination for the company. So far, Broadcom has had success with many small customers as well as certain big customers in China, though it claims that the progress so far has been slightly slower than what it expected. However, with the aim to develop more competitive products over next year, Broadcom is confident of increasing traction in the Chinese market.
Smartphone business constitutes the majority of Broadcom’s connectivity business. Broadcom declared that some of its customers will ramp a higher number of mid-range and higher-end smartphones with its dual-core products in the coming quarters. However, the company does not expect any material contribution from the same in Q4, though it estimates that to make a meaningful contribution to its revenues next year onward.
Broadcom, Qualcomm (NASDAQ:QCOM), Nvidia (NASDAQ:NVDA) and other chip makers stand to gain from Texas Instruments‘ (NYSE:TXN) exit from the smartphone and tablet market. In its recent earnings call, Broadcom stated that some of TI’s customers have switched over to Broadcom, which helped the company increase its share in the connectivity space in Q3 2012.
Reduction In Headwind From The Declining 2G Business
Earlier in Q2 2012, Broadcom declared that the anticipated cross-over from 2G to 3G came earlier than expected and had estimated the impact of softness in 2G to continuously decline over the course of the year. As expected, the 2G business continues to fall, but the portion has become fairly small and Broadcom expects this to reduce to zero by next year.
We expect growth in 3G baseband and increasing 5G Wi-Fi penetration to more than offset the anticipated slowdown in 2G baseband solutions and multimedia coprocessors. Additionally, apart from expanding in 3G baseband, Broadcom is also working toward broadening its product family to include LTE which we feel would help increase its competitiveness in the market.
Growth In Broadcom’s Set-Top Business
Higher set-top box platform sales contributed to a 2.6% sequential increase in Broadcom’s baseband business. The company is benefiting from strong demand for advanced set-top boxes in developed countries as service providers aggressively transition their subscribers to advanced services. Additionally, in Q3, Broadcom witnessed share gains and continued growth in pay TV subscribers in regions outside of Europe and North America.
Solid secular trends and Broadcom’s innovations continue to fuel its set-top box business. The company witnessed a number of positive developments this quarter:
- MoCA attach rate to cable set-top box platforms more than quadrupled over the last year.
- The introduction of NAGRA OpenTV 5 support across cable, satellite and IP set-top boxes and gateways, strengthened Broadcom’s security and content protection platforms.
- The industry’s first dual ISDB-T chipset for digital terrestrial TV in Latin America, a region that continues to be a strong growth driver for the company.
On the flip side, the strength in Broadcom’s set-top business is being offset by the roll-out of its Blu-ray and DTV businesses. However, the company is close to nearly completing its exit from the two markets; and thus, we do expect to see any adverse effect of these businesses in the future.
Softness in data center and enterprise spending
Broadcom registered a 5.2% sequential increase from its infrastructure and networking business in Q3 2012. However, the company claims that it is witnessing softness in demand this quarter (from US, Europe as well as Asia) on account of reduced data center and enterprise spending as well as lower service provider capital expenditures. Thus, Broadcom estimates a sequential decline in revenue from this segment in Q4.
We think that macro headwinds combined with seasonal variations is the primary reason for the conservative estimate. After the acquisition of NetLogic, Broadcom has been able to expand its potential addressable market by leveraging its expanded product portfolio. More recently, Broadcom introduced the first 28 nm multicore network chip demonstrating the successful integration of the two companies and claims to have scored considerable design wins with the same this quarter. (Read: Broadcom Retains Its Leadership With A Leap To 28 nm Multicore Network Chips)
With a focus on driving growth via innovation and expanding product portfolio, we believe Broadcom has the capacity to retain its foothold in the infrastructure and network market in the years ahead.
Our price estimate of $44.95 for Broadcom is at a premium of over 40% to the current market price.
Disclosure: No positions