An Options Play On Beaten-Down Broadcom

| About: Broadcom Limited (AVGO)
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I'm always looking for good investment ideas. I like to read a lot and then do my own homework on evaluating whether I'm going to take the leap and ultimately make a purchase. One of my favorite stocks is Apple (NASDAQ:AAPL); on December 29 of last year, I came across an article titled "Apple Can't Live Without This Stock." The article laid out an optimistic future for Broadcom (BRCM) from an investment standpoint -- at least enough for me to take a closer look.

At first blush I could see that BRCM was near its 52 week low -- having traded as high as $47.39 and as low as $27.59 in December 2011. It also paid a dividend of 1.2%. I'm a sucker for good companies that have been beaten down, so I definitely had to look closer. From the perspective of a 3-month chart, it appeared the stock was making lower lows and that dipping back or even below $27.59 was not out of the question.

Next was a look at BRCM's earnings and growth prospects. My investing experience has told me to stay away from companies that do not make money. That certainly wasn't the case with BRCM, which finished 2010 with EPS of $2.72, and has 2011 projected to come in at $2.83. Growth prospects didn't appear to be all that great with 2012 projected at $2.75, an actual decline of 2.8%, followed by 2013 at $3.07, for an increase of 11.6%. On January 6, when I was looking at the stock, it was trading at $29.40, thus sporting a current PE of 10.39. Not bad for a high-tech company connected to AAPL's supply chain and involved in the "right" areas as outlined in the article above.

I definitely like companies with cash and little or no debt (see my SA article on Apple). A closer look at BRCM's latest 10-Q reveals BRCM has cash and marketable securities of $4.2 billion and debt of 0.7 billion, for a net cash position of $3.5 billion, or $6.35 per share. Subtracting the $6.35 from the trading price of $29.40 at the time, then gave me a PE of 8.14. Further, the book value of the company stands at $11.04 per share. Even though it looked like the stock was making lower lows over the short term, it sure did appear from my analysis that this stock had to be close to a floor, or had already set a floor.

Then I noted that BRCM is in the midst of an acquisition of NetLogic (NASDAQ:NETL). Based on the company's press release, this acquisition at $50 per share in cash will put a pretty good dent in their coffers to the tune of $3.7 billion net of cash assumed. By no means is this a small acquisition for BRCM, which itself had a market cap of about $14.3 billion when I was looking at the stock on January 6.

I also note that BRCM was not afraid to make acquisitions. In fact, BRCM has recently made 4 acquisitions (Percello Ltd, Beceem Communications, Gigle Networks, Inc. and Provigent, Inc.). While I certainly don't mind a company that is aggressive and doing what is necessary to stay ahead or on top of the market, I'm also not foolish enough to believe that it's easy to purchase and integrate a company into another company. Also, with caution surrounding Q4 results to be released at the end of January, I was now not 100% confident about making a complete plunge on the long side by purchasing the stock.

At this point in my analysis on BRCM, I'm really intrigued by the prospects but also cautious about the near term. My belief is that the stock at $29.40 (on January 6) was at or close to a floor. I decided to take a look at options. Writing (selling) a put contract is similar to providing an insurance policy for someone that already owns the stock, because it gives that person the right to put the stock to you, by a certain date, if the stock falls below the strike price of the option.

But heck, if I really want to buy the stock anyways, it doesn't seem like a bad idea that someone would be willing to pay me to buy the stock from them at a lower price than what it is trading at today. The risk is that the stock might never fall to or below the strike price, in which case I will not get the stock put to me. However, if that does happen, I'll still get to keep the premium paid to me for the "insurance policy" I sold.

I was intrigued by the May 19, 2012 $28 strike price put options on BRCM. They were selling for $2.15 per contract (one contract equals the rights to 100 shares of stock). This means that if I was to sell that put contract on BRCM, the purchaser of the option would pay me $215 and then have the right to make me purchase 100 shares of BRCM if the stock fell below $28 on or prior to May 19, 2012. If the shares never fall to $28, I would be able to keep the $215 per contract if held till expiration.

However, if the shares actually did get put to me my true cost for each share is not the $28 but instead $28 less the $2.15 that I will be paid for the "insurance policy" that I sold, leaving me with a basis of $25.85 per share. That sure didn't seem like a bad deal to me, based on my analysis, so that's exactly what I did. So while I'm technically not in BRCM, I am optimistic on the stock via the puts I've written.

As of this writing, the options contracts I sold are up nearly 35% due to the increase in the price of BRCM to over $31 per share. I still believe writing puts is a great way to get into this stock given its current valuation and potential caution and pessimism regarding the pending acquisition of NETL and the pending release of Q4 results. As always, do your own research and make sure you understand the risks of any trades that you make.

Disclosure: I am long AAPL, and May 2012 $28 puts on BRCM. Over the next 72 hours I may write additional puts, purchase call options or purchase BRCM outright.