The wireless connectivity business is the most valuable segment for Broadcom (NASDAQ:BRCM) in our view, accounting for 38% of its valuation and more than 40% of its revenue. The company is the number one player in connectivity with most of the high end smartphones using its wireless connectivity solutions. We forecast only a slight increase in Broadcom’s connectivity market share going forward. Our $46 valuation for Broadcom is at an approximate 10% discount to the current market price. If our estimate does not hold true, and Broadcom’s market share in connectivity solutions increases to 40% over the next 6-7 years, there will be a 10% increase in our valuation for the company. You can see the modified model and the resultant impact on key financial estimates here.
Why We Believe Broadcom’s Wireless Connectivity Share Will Remain Stable?
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– Intense competition might make it difficult for Broadcom to gain additional market share: Broadcom has been the leader in connectivity solutions for many years, currently accounting for approximately 30% of the market. Thanks to Broadcom, wireless technologies such as Bluetooth and Wi-Fi have become household names. Factors that drive demand for Broadcom’s connectivity business include: 1) new phone launches; 2) rising consumer adoption of new high end phones; 3) growing penetration of new technologies such as 802.11ac and 2×2; and, 4) the ramp of new highly integrated products (e.g., the location hub) that also command higher ASPs. The company claims to be seeing significant customer interest in its latest 5G Wi-Fi chip that offers an industry first real simultaneous dual band or RSDB.
Nevertheless, there is intense competition in the market. The acquisition of the Atheros portfolio better positioned Qualcomm (NASDAQ:QCOM) to offer solutions that can compete with Broadcom’s offerings. In the past, Broadcom has lost some low-cost smartphone sockets to Qualcomm, including the HTC One Mini, Samsung Galaxy S IV Mini, and the Motorola X. Additionally, Samsung’s acquisition of CSR’s mobile phone connectivity and location technology strengthens its platform by extending silicon capabilities in Wi-Fi and GPS, and also boasts of an enhanced patent portfolio. Broadcom is a large supplier of chips to Samsung. The acquisition could become a potential threat in the long run if Samsumg is able to successfully turn the CSR business to compete with Broadcom.
– Exit from the baseband business could impact Broadcom’s connectivity market share: Owing to the rising competition in the market, Broadcom exited the cellular baseband business in 2014. A substantial increase in R&D expenses for developing cellular baseband products significantly lowered Broadcom’s mobile and wireless operating income over the past few years. The baseband market is quite R&D intensive, and Broadcom had spent over $3 billion on cellular baseband related R&D since 2007 without earning any profit. ((Intense 3G Price Competition and 4G LTE R&D Took Toll On Broadcom Baseband Business, Strategy Analytics, June 2, 2014)) Broadcom’s connectivity business and baseband business went hand-in-hand, and the baseband exit could cost the company some customers in connectivity. While Broadcom remains confident of retaining its strength in the high-end, it did expect its exit from the baseband business to negatively impact the low-end of its connectivity business.
Factors That Can Help Broadcom Increase Its Supremacy In Connectivity Solutions
– Low-cost market share loss has not yet materialized: A quarter or two back, Broadcom expected its connectivity business to decline in 2015. However, the company now claims that its overall connectivity portfolio is definitely strengthening and expects the business to be flat or even up on a year-on-year basis this year. Broadcom claims that the concerns it had about the loss of business on exiting basebands have not materialized and the company does not expect them to at this point. On the contrary, the company has in fact gained share in the low-end of the market in the last few quarters. Some of Broadcom’s partners are gaining share in the baseband space, which helps Broadcom’s penetration in the market. If the company continues to gain market share in the low-cost segment, it can manage to increase its share in connectivity in the future.
– Expanding footprint in Internet-of-Things (IoT): As smartphones and tablets achieve wide penetration, there is little doubt that IoT will be the next major driver of growth for the semiconductor industry. Though its parameters and standards are only now being established, its impact is likely to be both wide and deep. IoT technology allows computing and control functions to be deployed widely across everyday devices via a number of wireless communications, ranging from Near-Field through Bluetooth to WiFi and cellular spectra. Being a leader in wireless connectivity, Broadcom is at the forefront of IoT innovation, offering a gamut of connectivity hardware and software solutions for a broad range of IoT end markets. Over the years, Broadcom has strengthened and diversified its portfolio with new low power connectivity solutions for IoT. Last year, the company launched its WICED platform, a low-cost, low-power development tool that provides out-of-the box connectivity to help get new IoT products to market faster. Broadcom’s expertise in wireless solutions positions the company well to leverage IoT expansion across a wide range of market segments.
– Acquisition by Avago can strengthen Broadcom’s wireless business: Broadcom and Avago Technologies entered into a definitive agreement May this year, where the latter will acquire the former in a cash and stock transaction. The acquisition is expected to close by the end of the first calendar quarter of 2016, subject to regulatory approvals in various jurisdictions, and the combined company will be known as Broadcom. Avago Limited is a leading designer, developer and global supplier of a broad range of analog semiconductor devices, with an extensive portfolio in four key markets: wireless communications, enterprise storage, wired infrastructure, and industrial and other. The combination of Avago and Broadcom will create a global diversified leader in wired and wireless communication semiconductors. The positive synergies from the merger might enable Broadcom to increase its competitiveness in connectivity solutions.