Broadcom: A Successful Serial Acquirer
Summary
- Broadcom is a diversified semiconductor and software infrastructure company.
- It has a high free cash flow conversion and uses that to pay a high dividend. The current forward dividend yield is about 4%.
- The company was built with acquisitions which also significantly increased debt over the past few years.
Introduction
Broadcom (NASDAQ:AVGO) is one of the largest semiconductor companies in the world. Over the past few years, it has built the company through acquisitions. This has caused revenue to soar. Revenue more than tripled from 2015 until 2019. Broadcom funded these acquisitions with a lot of new debt on its balance sheet. It also differentiated its business through these acquisitions. It became a combination of semiconductors and infrastructure software.
This worked out very well over the past few years. Revenue accelerated impressively and they've been able to increase dividends as well. This all came at the expense of a large pile of debt. The share price has gained impressively as well:
Data by YCharts
Impressive Cash Flow
According to the second-quarter results, Broadcom reported a free cash flow of $3,065 million. Broadcom mastered the art of turning acquisitions in more free cash flow. The free cash flow from operations jumped $523 million since the second quarter of 2019. It's not clear how much came from the Symantec acquisition. It should be substantial as semiconductor revenue is stable and infrastructure software revenue rose by 19%.
There are some remarks about this free cash flow. They've had costs related to acquisitions which they exclude from this free cash flow. This is correct as these costs shouldn't be structural. However, since they've done so many acquisitions, this seems to have become a continuing cost. The company explicitly states that acquisitions are a part of the business strategy:
Our strategy is to combine best-of-breed technology leadership in semiconductor and infrastructure software solutions, with unmatched scale, on a common sales and administrative platform to deliver a comprehensive suite of infrastructure technology products to the world’s leading business and government customers. We seek to achieve this through responsibly financed acquisitions of category-leading businesses and technologies, as well as investing extensively in research and development, to ensure our products retain their technology leadership. This strategy results in a robust business model designed to drive diversified and sustainable operating and financial results.
Source: 2019 10-K
Another big part of non-cash costs is stock-based compensation. This is $517 million in the second quarter. This isn't a cash expense but does have an impact on shareholder value.
Dividend Increased Very Fast
Broadcom has substantially increased its dividend since starting payouts in 2011 when it was Avago Technologies. Especially since 2015, the increase is impressive. Dividends grew from $1.55 yearly to $13 expected for 2020. This is an impressive 838% increase:
Data by YCharts
And so we're pretty committed to the dividend as you can expect, and the cash flows are there to support that.
Source: Earnings Conference Call March 12, 2020
Looking forward, Broadcom has stated it's committed to the dividend. This means they should at least keep the dividend stable for the time being. It recently stopped buybacks, favoring paying down debt. This could also mean there is little room for (large) dividend increases soon.
It's good that they're paying down debt at the moment. The high debt position could quickly endanger the dividend in case of a downturn in business. At a debt position of $44.7 billion, $3 billion quarterly free cash flow, and $1.387 million in dividend, $375 million in interest it will take a long time to pay back. Broadcom could also sell some parts of the acquisition to pay a part of the debt back as it did before.
A Lot Of Debt, Sufficient Time To Pay Off
While Broadcom talked about a healthy balance sheet in the most recent earnings call, I believe the debt position is rather high.
Data by YCharts
In nominal terms, the long term debt is at $44.7 billion. This debt is offset by little actual assets. Most of Broadcom's assets are goodwill and intangible assets from takeovers.
Source: Q1 10-Q
This one way to look at the debt. Another would be to see how debt compares with cash flows or more commonly used, EBITDA.
Data by YCharts
It paints a good picture of how Broadcom kept debt in line with its EBITDA over the past few years. Every acquisition added very fast to revenue and free cash flow keeping the debt ratio at a relatively low level. The most recent ratio on the chart isn't completely correct. It takes into consideration all debt of the Symantec acquisition, while it has only contributed 2 quarters to the results.
Broadcom is producing stable results and doesn't show much effect of the coronavirus. They should be able to get the long term debt/EBITDA ratio down over the next couple of quarters by paying back some debt and further increasing EBITDA. Broadcom has also made sure that it has enough time to pay down debt. Recent debt restructuring put debt repayments further in the future. It kicked the can a lot further down the road. This is how it looked before the restructuring:
Valuation And Comparison To Peers
Broadcom can't be valued by P/E at the moment. The acquisitions increased amortization significantly and consequently reduces classic earnings. I will compare Broadcom to Qualcomm (QCOM) and Intel (INTC) using the EV to EBITDA. EV or enterprise value equals the market cap, including the net debt or deducting net cash. The EBITDA is the most comparable because it excludes all one-time write-offs, etc.
These companies aren't just comparable. Both Qualcomm and Intel have their opportunities and challenges, which can't be included in one comparable. It only shows a bit of their past financial performance.
Data by YCharts
This chart hides a crucial difference. While Intel and Qualcomm performed decently over the past 10 years. Broadcom improved its financial results and was rewarded by a higher stock price as well:
Data by YCharts
The first chart shows Broadcom isn't above its historic valuations. In comparison to peers, it's valued higher. This can be justified by the recent performance and successful acquisitions of Broadcom. As long as Broadcom keeps strong growth going and creates more value, it will keep this high valuation. The higher debt adds extra risk to Broadcom, making it a high risk, high reward investment at the moment.
Conclusion
Broadcom successfully built up a semiconductor and infrastructure software imperium with acquisitions. It has a broad portfolio that produces impressive cash flows. The business model is based on more acquisitions. Debt, or at the least the debt ratio, should be reduced before it can do another large takeover. This ratio should come down pretty fast over the next couple of quarters.
It seems the stock is valued correctly after the fast recovery since March. The performance has been great and it's in the right technologies for growth. But valuations aren't as subdued as a couple of weeks ago and the debt could add risk, especially if results disappoint. In the long term, I would expect Broadcom to grow further and keep using cash for dividends and possibly new acquisitions. If the valuation drops, buybacks would be a good idea as well.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Any investments you would take after an article or discussions with me are your responsibility. You should do your own due diligence before an investment.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (14)
