Broadcom’s broad portfolio more affordable to investors post stock split
Welcome to Stock Takes, my weekly take on an individual stock. I look at the big picture, unlike Wall Street analysts who are geared to earnings reports, and the media that focuses more on news value.
Another AI play that has come out with a recent 10-for-1 stock split to make its shares more affordable, Broadcom Inc. (NASDAQ: AVGO) started trading on a post-split basis on July 15. It closed at about $160 on July 18 and the stock also got a boost that day due to speculation that it is in talks with Open AI to develop custom chips for the latter (to power AI models such as Chat GPT).
Broadcom Corporation, founded in 1991, was acquired by Avago Technologies in 2016, but retained its name (though the company trades on the Avago ticker symbol). The company has grown through a series of acquisitions, such as Symantec Corp., and more recently VMware. Avago Technologies started off in 1961 as a semiconductor division of Hewlett-Packard, and also grew by acquiring companies such as LSI Corp.
The company, providing technologies that serve to connect the world, has two main divisions, semiconductor solutions and infrastructure software solutions. According to Broadcom, the semiconductor solutions segment mostly earns money from “a broad range of semiconductor devices that are incorporated into electronic products, as well as from modules, switches and subsystems” and from sales of “software solutions that enable our customers to plan, develop, automate, manage, and secure applications across mainframe, distributed, mobile, and cloud platforms.” Its products are used in a variety of avenues, including smartphones, data center servers, networking, telecommunications equipment, and factory automation.
And Broadcom’s infrastructure software solutions “enable customers to plan, develop, automate, manage and secure applications across mainframe, distributed, mobile and cloud platforms.” This division also offers fiber channel storage area networking (FC SAN) products and related software.
Recent AI tailwinds
The growth of AI development has spurred recent growth for the company.
For the period ended May 5, 2024 ( the second quarter of its fiscal 2024 year), Broadcom reported revenues of $12.4 billion, up 43% from the 2023 second quarter. Excluding the contribution from VMware (which was acquired in November 2023), revenues would have been up a more moderate 12%.
Earnings per share were at $4.42, compared to $8.15 for the 2023 comparable period. However, on a non-GAAP basis ( after making some adjustments to its net income reported based on Generally Accepted Accounting Principles, or GAAP), Broadcom reports earnings per share of $10.96 for the 2024 second quarter, up more than 6% from the 2023 second quarter. According to Broadcom, the non-GAAP measure excludes input that doesn’t reflect its underlying performance and provides a better idea about its “on-going performance.” For instance, restructuring and integration costs related to the VMware acquisition that reduce GAAP earnings do not reflect the company’s underlying performance.
Hock Tan, Broadcom’s president and CEO, noted "Broadcom's second quarter results were once again driven by AI demand and VMware. Revenue from our AI products was a record $3.1 billion during the quarter. Infrastructure software revenue accelerated as more enterprises adopted the VMware software stack to build their own private clouds.”
For its fiscal year 2024, Broadcom is anticipating revenue of $51 billion, with adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) of $31 billion. For the 2023 fiscal year, the company reported net revenue of $35.8 billion.
On Broadcom’s second quarter earnings conference call, Tan noted that the 12% growth in revenue for the period (excluding the VMware contribution) was largely thanks to AI revenue, which grew 280% over the year to $3.1 billion, which largely helped offset “continued cyclical weakness in semiconductor revenue from enterprises and telcos.” For fiscal 2024, the company expects AI-driven revenue to be more than $11 billion.
Revenue from the company’s networking market was up 44% in the second quarter over the year, representing 53% of its semiconductor segment revenue, thanks to big demand from hyperscalers, or large-scale data centers. It seems Broadcom is benefiting as the AI race calls for more investments in such data centers. The company would also be interested in creating custom application-specific integrated circuits for hyperscalers.
Tan noted, “Non-AI semiconductor revenue has bottomed in Q2 and is likely to recover modestly for the second half of fiscal '24. On infrastructure software, we're making very strong progress in integrating VMware and accelerating its growth.”
Customer complaints follow VMware acquisition
Broadcom is always on the lookout for opportunistic acquisitions, and the VMware acquisition enables it to add virtualization software that allow businesses to develop their own virtual private clouds to its product offerings. For the second quarter, revenue from VMware, at $2.7 billion (up from $2.1 billion for the previous quarter) accounted for about 50% of the company’s infrastructure software solutions segment’s revenue of $5.3 billion.
According to Tan, the integration of VMware is going well, and Broadcom has consolidated VMware’s myriad offerings to just four core products. While costs relating to VMware’s integration and restructuring have been $2 billion through the second quarter, there has also been cost cutting and consolidation of selling and administrative functions that has enabled spending to go down. These measures caused spending to drop to $1.6 billion in the second quarter, from what used to be $2.3 billion per quarter pre-acquisition. When the integration is completed, Tan expects this spending to stabilize at $1.2 billion per quarter.
It seems Broadcom has a pattern of slashing costs with the companies it acquires, by laying off employees, slashing marketing costs and cutting off underperforming divisions.
VMware customers have not been happy with some changes introduced by Broadcom. For one, the company’s move to recurring subscription-based pricing over its previous perpetual license model (whereby customers just paid once for the service) has not gone down well with customers. Broadcom has also jettisoned some agreements with VMware service providers and resellers.
According to Tan, VMware has been late in moving to a subscription-based pricing model, which other technology companies such as Oracle, Microsoft and Salesforce are already using. And instead of just offering server or compute virtualization, VMware is now offering “the whole software stack to use vSphere and its basic fundamental technology to virtualize networking, storage, operation, and management, the entire data center, and create this self-service private cloud.” Customers are interested in this model and see it as a complement or even alternative to public cloud offerings, he said.
This might help VMware face the heightened competition in recent years after the emergence of big cloud services providers such as Amazon Web Services. Broadcom also faces other risks.
Customer concentration, regulatory and trade risks
Broadcom’s sales to Apple accounted for about 20% of its net revenue for its fiscal 2023 year (it provides components for Apple devices), the company reports. And sales to its top five end customers made up about 35% of its net revenue for that period. This creates a risk of customer concentration and could cause a significant loss of revenue if it loses any of these customers.
Broadcom also outsources the majority of its manufacturing needs to companies such as Taiwan Semiconductor Manufacturing Company and Advanced Semiconductor Engineering. It is also dependent on outside suppliers for a variety of raw materials such as silicon, precious metals and chemicals. Moreover, the company hasn’t hedged its exposure to commodities, whose prices fluctuate often. Not only that, trade tensions with China could impact supplies of raw materials and Broadcom could face rising competition from domestic producers as a result of the CHIPS Act.
And Broadcom is subject to various government regulations governing privacy and data security, as well as environmental protection laws relating to the use and disposal of hazardous materials.
The company also faces a host of competitors for its multiple offerings, ranging from integrated device manufacturers and semiconductor companies in the semiconductor solutions space to enterprise software vendors in the infrastructure software solutions space. These include companies such as Intel, Cisco and Amazon Web Services. Broadcom looks to compete based on its design expertise, broad product portfolio, technology, global reach and customer relationships.
Broadcom could benefit from AI, but its portfolio is very broad
On the financial front, the company’s book value per share following the stock split is about $15, making for a price-to-book ratio of about 10.5. Its price-to-earnings ratio, based on fiscal 2023 earnings per share of $3.29, adjusting for the stock split, is about 48. Considering the potential for rising earnings, its forward P/E could be more favorable.
As of its fiscal 2024 second quarter, Broadcom’s current ratio of 1.25 times indicates that its current assets are more than adequate to cover its current liabilities. Its gross profit margin was at a healthy 62%. Its debt-to-equity ratio of about 1.05 times is acceptable too, but the company has a big debt load of about $74 billion, including debt that it took on for the VMware acquisition. Some of the company’s debt bears floating interest rates that it does not hedge, exposing the company to interest rate risk. Also, the debt carries restrictive conditions that could impede Broadcom’s business strategies.
While Broadcom is certainly benefiting from growth in AI, its portfolio is broad and its growth strategy seems to be more based on acquisitions than organic growth. It has turned in a return of more than 80% in the last year and shareholders could hold on to the stock, but it seems there are better AI plays.
Note: I do not own any individual Broadcom stock and I do not intend to take a position in the stock within five days of publication of this article. This write up is my unbiased opinion and not intended as financial advice. All investments carry risks and you should talk to a financial advisor to learn about the suitability of an investment for your portfolio. I did not receive any compensation for this piece that influenced my views.