Broadcom (NASDAQ:BRCM), a global leader in semiconductors for wired and wireless communications, reported its Q3 2013 results last month. Generating $2.15 billion in revenues, the company experienced 2.7% quarter-over-quarter and a 0.8% year-over-year growth in its top-line, much in line with its expectation. It posted a gross profit margin of 51.4% in the quarter, compared to 50.0% and 50.7% in the prior year and quarter, respectively, as it benefited from a better-than-expected mix and a decline in excess and obsolete inventory.
Broadcom registered 11% sequential growth in Infrastructure and Networking segment, which had revenues of $564 million (26% 0f the total). The Mobile and Wireless segment, in turn, grew 5% quarter to quarter to $1.02 billion (48%) and its Broadband Communication segment (with revenues of $547 million) was roughly flat. Driven principally by weakness in its access business, Broadcom guided to a sequential decline in its broadband business in the current quarter.
We are going to take an in-depth look at this third business in particular. Though short-term headwinds can impact Broadcom’s broadband business in the next few quarters, we are positive on its long term growth potential as it remains a leading player in the global set-top box market. Broadcom offers a wide range of solutions for key markets including video set top boxes (cable, satellite, IPTV) and residential broadband access. It generates close to 28% of its revenues from its broadband business and derives approximately 20% of its valuation from the segment, as per our estimate.
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Our price estimate of $38 for Broadcom is at a significant premium to the current market price of $27.
Set- Top Business Is A Key Growth Driver
Broadcom reports that the set-top market continues to be a key growth driver for its broadband business. It shared the top spot in the worldwide set-top box integrated circuit (IC) market with STMicroelectronics in 2012. While both companies shipped between 85-86 million video SoCs for set-top boxes last year, Broadcom earned higher revenues as it accounted for significantly larger value design wins within the North American and Western European cable and satellite markets.  Witnessing 15% higher set-top box sales in 2012, Broadcom gained additional market share and delivered strong growth and profits throughout the year.
ARM Holdings, which provides the processor cores used to develop these SoCs, forecasts that the shipments for digital TV and set-top box will increase to 600 million units by 2017, compared to 420 million units in 2012.THis equates to a compounded annual growth rate 0f 9.3% Currently, set-top boxes on average use 1 to 2 advanced ICs per device. However, with increasing technological development in the digital space, ARM estimates the number will increase to as high as 4 chips per device by 2017.  Thus, total processor shipments for these devices in all likelihood will grow faster than the overall market.
Macro headwinds, increasing competition, growing demand from less technology-intensive emerging markets, and declining average selling prices (ASP) will all challenge Broadcom’s ranking in the set-top box market. Nevertheless, with a focus on innovation and the addition of entry-level systems to its portfolio, the company is in a strong position to retain its leadership in the global set-top box market, in our view.
Growing demand from emerging markets driving set-top box shipments:
Owing to the economic slowdown, the global set-top box market has experienced slow growth in the last few years. Trends look brighter going forward, however. Research firm Infonetics Research estimates the global set-top box revenue growth approached 10% in 2012.  Though macro challenges will inevitably lower growth in certain years, global set-top box shipments are forecasted to increase from 221 million in 2011 to 242 million in 2016.  This incorporates compounded annual growth of 9.7%.
Rising demand from Asia, Latin American and a number of countries in Europe, along with the ongoing shift from standard-definition products to high-definition products in developed markets, is driving demand for set-top boxes. Emerging digital TV markets in China, India, Latin America and Russia are forecast to account for 45% of the total set-top box shipments between 2011-2015.
The cable and terrestrial digitization projects in emerging markets are expected to drive robust growth in set-top box shipments. Digitization of the Chinese and Indian cable platforms, China’s free-to-air satellite expansion, and pay-satellite growth in India and Latin America are forecast to require close to 500 million set-top boxes between 2011-2015. 
Broadcom has been continuously innovating its product portfolio to expand its footprint in the rapidly expanding low-cost set-top box market. In Q1 2013, it introduced the latest generation of set top box SOCs for entry level systems, which is a cost effective platform that offers advanced video experiences to subscribers. The company indicates that it is increasing penetration of its products across the BRIC countries.
Technological growth to drive Broadband demand in the developed markets:
Broadcom’s primary customers are located in North America and Western Europe. Though subscriber growth in developed markets remains low, increasing technological intensity is high and will help drive future growth in these markets. Broadcom claims to be witnessing increasing content driven by transcoding, MoCA (Multimedia over Coax Alliance), and HEVC (High Efficiency Video Coding) technology in the region.
With a strong IP portfolio, best in class technology and global reach, Broadcom is confident of its strong position in the broadband market. In its latest earnings call, management declared that it is seeing meaningful design traction in broadband access and accelerating revenue growth in PON (Passive Optical Network). Additonally, it continues to lead the industry in videocell and vectoring and expects to see continued growth from these technologies as service providers upgrade infrastructure and deploy the latest gateway platforms to subscribers.Notes:
- Broadcom and STMicro Tie for Top Slot in Set-top Box IC Market as Ali Technology Gains Ground, ABI Research, April 25, 2013 [↩]
- ARM Holdings Q4 2012 Analyst Presentation [↩]
- STB market springs back; video getaways, media players drive future growth, Infonetics Research, April 8, 2013 [↩]
- Global Research of Set-Top Boxes Market – Global Industry Size, Market Share, Trends, Analysis and Forecasts 2012-2018, SB Wire, March 15, 2013 [↩]
- Emerging Markets Account for 45 Percent of all Set-top Boxes Shipped Globally between 2011 and 2015, IMS Research Forecasts, August 11, 2011 [↩]