Despite Short-Term Headwinds Broadcom’s Long-Term Growth Is Intact

Leading semiconductor provider for wired and wireless communications, Broadcom (NASDAQ:BRCM), reported its Q3 2013 earnings on October 22.  Our price estimate of $41 for Broadcom is at a significant premium to the current market price of $27 and we continue to believe in the company’s long-term growth potential. We are in the process of updating our valuation to incorporate the Q3 2013 earnings.

Recap of Q3 2013 Earnings

Earning $2.15 billion in revenues the company witnessed a 2.7% q-o-q and a 0.8% y-o-y growth in its top-line, much in line with its expectation. Broadcom earned a gross profit of 51.4% in Q3 2013 as compared to 50% and 50.7% in Q3 2012 and Q2 2013, respectively, as it benefited from stronger than expected mix and a decline in its excess and obsolete inventory.

While Broadcom registered an 11% and 5% sequential growth in networking and handset segments respectively, its broadband communication business was roughly flat. Anticipating the short-term headwinds to impact its growth, Broadcom estimates a sequential decline in all its business segments – baseband, broadband and networking – in the current quarter. However, it accepts growth to accelerate in 2014 backed by the LTE certification early next year, continued strength in data center as well as rising 5G Wi-Fi and other multiple technology transitions.

See Our Complete Analysis for Broadcom Here

Broadcom To Retain Its Connectivity Share With Growing 5G WiFi Penetration

Broadcom’s wireless connectivity sales were roughly flat sequentially as it underwent a channel inventory correction and a mix shift towards 802.11 in the quarter. The 15% q-o-q growth in its WiFi combo and rising NFC sales were offset by lower discreet connectivity revenue. Broadcom believes that the mix shift is a short-term trend and claims that its customers are firmly committed to 5G Wi-Fi. It expects higher 5G Wi-Fi penetration in 2014.

With a 32.8% market share, Broadcom has been the leader in connectivity solutions for many years. In the last few months, it lost a number of low cost smartphone sockets to Qualcomm (NASDAQ:QCOM), including the HTC One Mini, Samsung Galaxy S IV Mini, and the Motorola X, which had raised doubts about its capability to retain share in the wireless connectivity market. However, the company claims that its connectivity market share remain stable as it won designs from new customers that offset the loss of a few handsets.

In addition to its strength in connectivity technologies – 5G Wi-Fi and NFC – Broadcom is investing in emerging growth opportunities in nascent market for Internet of things and wearables. We believe it will continue to retain its market share in connectivity solutions over our forecast period.

LTE Certification To Expand Presence In The Baseband Market

Currently, Broadcom does not have a very large customer base for its 3G business and accounts for only 3% of the mobile baseband and application processor market. However, we believe the LTE certification will help expand the company’s foothold in the baseband market. Of the various technologies that are driving the market currently, LTE is seeing the strongest growth as carriers around the world increasingly shift to the new standard for wireless communication.

Broadcom announced its first LTE-compatible baseband chip earlier this year. It claims it to be 35% smaller compared to current products making it the industry’s smallest 4G LTE chip in the market. Earlier this month, Broadcom closed its acquisition of the LTE-related assets of Japanese chipmaker Renesas Electronics. The deal gives Broadcom access to a dual-core LTE SoC that is ready for volume production and is carrier-validated by leading global operators in North America, Japan and Europe. Broadcom claims that the acquisition of LTE-assets from Renesas will help it accelerate the production of its first multimode, carrier-validated LTE SoC platform into early 2014.

“Our goal is to introduce a quad core LTE platform next year and the driver LTE technology toward the leadership platform to enable us to cover the complete spectrum of LTE devices. We’re poised to gain share in 4G LTE starting in early 2014.”

Strong Growth In Infrastructure & Networking

Earnings $564 million in revenues Broadcom saw continued strength in its infrastructure and networking segment. The data center business grew by more than 20% in 2012 and the company expects a similar growth rate for 2013 as well. Data center remains a strong growth driver for the company with Broadcom’s leadership in high density Ethernet switch. Its next generation Trident II is now in volume production and Broadcom expects the same to contribute to its growth momentum in networking through next year.

Equipped with NetLogic’s leading multi-core embedded processor solution, Broadcom has managed to expand its potential addressable market and earn higher revenue from the infrastructure and networking market. We believe that the upward trend will continue in the future as well.

Q4 2013 Outlook

– Net revenue in the range of $1.79 billion to $1.98 billion, +/- 3%.

– GAAP and non-GAAP product gross margin to be down approximately 0.5% to 1%.

– Non-GAAP and GAAP R&D and SG&A expenses to increase by $40 million to $60 million.

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