Broadcom: The Best Option All Along

| About: Broadcom Limited (AVGO)

Summary

Broadcom announced a monster stock buyback plan.

The company needs to assure the market it can grow without acquisitions.

The regulatory environment and the stock valuation are right for Broadcom to buy itself.

As the semiconductor sector runs into issues with closing deals due to U.S. and Chinese government delays, Broadcom (AVGO) announced a major stock repurchase plan. Based on where the stock trades, this option was the best one all along.

Source: Broadcom presentation

Market Doubts

After years of acquiring other companies and building Broadcom into a $100 billion stock, the market now doubts the ability of the tech company to grow earnings organically. The company is now best known for slashing costs and running a tight ship with operating expenses including research and development costs under control.

At the same time, CIFIUS and President Trump blocked the attempted Qualcomm (QCOM) deal while Chinese regulators are delaying several semi mergers including the merger between Qualcomm and NXP Semiconductors (NXPI). Both scenarios suggest Broadcom will have a difficult time growing via any major acquisition in the near future.

The best option all along is for Broadcom to buy itself. The stock only trades at roughly 12x '18 EPS estimates of nearly $20. What better option exists to avoid all of the regulatory issues than to just repurchase one's own stock, especially when the stock trades below a market multiple.

After all, Barclays reinstated coverage on Broadcom with a target price of $335. If the analyst is accurate, the company should buy all the stock possible when trading below $250.

Capital Allocation Plans

On April 12, Broadcom announced plans for a $12 billion stock buyback. The plan is effective until November 2019 and would amount to about 12% of the outstanding shares at the current stock price.

In such cases, the big question is whether the company will actually pull the trigger and make the stock purchases. Broadcom pays a $7 annual dividend for a 2.8% yield. The amount is far below the forecasted $20 EPS this fiscal year.

The biggest problem is that the balance sheet isn't impeccable due to the acquisition spree. Broadcom has $17.6 billion in debt and about $10.5 billion in net debt. Clearly, Broadcom will have the cash flows to handle stock buybacks without borrowing money, but the company will forego the opportunity to improve the balance sheet.

The CFO made clear to distinguish the goal of this stock buyback plan:

The initiation of a stock repurchase program enhances our capital allocation strategy and provides us with a complementary tool to deliver value to our shareholders. We are maintaining our policy of delivering 50% of trailing 12-month free cash flow to shareholders in the form of dividends while adding the ability to use the balance of our free cash flow not only for acquisitions but also for opportunistic buybacks.

After spending 50% of trailing FCF on dividends, Broadcom will make stock repurchases only when the price is attractive. The key to the story is the stock trading at 12x forward EPS estimates is the time to be opportunistic. A significant buyback can further reduce that P/E multiple. A quick $5 billion buyback would reduce the outstanding share count by 5% from 464 million shares to 441 million shares.

Naturally, the FY19 EPS estimate would jump from $20.82 to $21.91 in this scenario. The company would quickly boost the EPS estimate for next year by over $1 just from utilizing FCF to buy shares. No need for another BOD to approve a lengthy buyout. No need for regulatory bodies in the U.S. and China to approve the deals. All while not even using 50% of the authorized buyback.

Just the 5% stock buyback would help Broadcom grow FY19 EPS by 10%. Utilizing the full buyback would lead to EPS surging by over 15%.

Takeaway

The key investor takeaway is that Broadcom is a relatively cheap stock facing regulatory issues with a merger. The stock has now traded flat for going on a year, but the semiconductor giant as a solution to the problem. The best option now is to utilize cash flows to repurchase shares on the cheap and prove to the market that Broadcom can grow organically.

Disclosure: I am/we are long QCOM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.