Yesterday, Dec. 10, Broadcom (NASDAQ:BRCM) hosted the Broadcom Analyst Day in New York, and presented increased earnings projections for the fourth quarter. The management now expects revenues to reach between $2.0 billion and $2.05 billion, up from its former estimates of between $1.91 billion and $2.03 billion. Expectations regarding gross margins and operating expenses were also raised, although not as much. In this context, I would like to take a look at the company´s prospects and stock valuation in order to elucidate if it stands as an attractive long-term investment opportunity. Evidently, investment gurus like George Soros, Bill Miller and Joel Greenblatt seem to believe this — they all bought substantial amounts of Broadcom´s stock lately and rank among the top 20 hedge fund bulls on the company.
With more than 50 major hedge funds holding long positions in the company, Broadcom places itself between the 20 favorite tech stocks among institutional investors. In fact, this semiconductor giant experienced a marked decline in hedge fund bullishness over the past quarter.
Despite the Management´s Confidence…
Broadcom provides semiconductors for wired and wireless communications. With a market cap of more than $16 billion, it has established itself as a market share leader in various segments like enterprise networking and mobile connectivity. Nonetheless, competition in the industry is fierce, which means that the company’s future profitability is not ensured. Despite the management´s increased guidance for the ongoing quarter, analysts (consensus estimates) expect modest sales growth for the upcoming quarters — 2.8% for 2013, and 3.5% for 2014. EPS growth estimates are not that attractive either: Over the next five years, analysts project an annual average EPS growth rate around 8% to 9.5%, about half its industry´s average.
The main issues that are expected to cap Broacom´s profitability are its constant R&D expenses, intense competition in key segments like mobile connectivity — where Qualcomm (NASDAQ:QCOM) is a huge player — and the pressure on margins exerted by its shareholder-friendly policies, the introduction of new products, and the integration of acquired companies.
There are also other considerable risks associated with Broadcom´s business. For starters, client concentration poses a big threat to earnings predictability. The company obtains a sizable percentage of its overall revenue from a few big clients. This means that any setbacks regarding them would have a significant impact on Broadcom´s finances.
Another risk to consider is related to its business model: Broadcom is fabless. This implies a huge dependence on third-party foundries to fabricate their chips, and the impossibility of integrating its productive and distributional operations.
|Rev Growth (3 Yr Avg)||21.3||12.9||14.9||19.6|
|Net Income Growth (3 Yr Avg)||122.5||34.2||36.1||23.0|
|Operating Margin % TTM||6.6||15.8||22.7||35.7|
|Net Margin % TTM||6.1||12.1||18.1||31.7|
|EPS Annual Growth Estimate (5 yrs)||8%-9.5%||14%-17%||5%-6%||15%|
As you can see in the table above, Broadcom´s valuation in relation to its earnings is not very attractive. Although it does generate considerable amounts of cash, management has not been very effective in reinvesting it or widening margins. Compared to competitors like Intel (NASDAQ:INTC) and Taiwan Semiconductor Manufacturer (NYSE:TSM), which offer better P/E ratios paired with wider margins and returns (and much higher growth projections, in TSM´s case), Broadcom´s stock price just doesn´t look right. So, even though this tech giant may look like a safe investment, that even pays out about 1.5% of the current stock price in the form of dividends, other options in the industry provide better prospects or financials at a significant stock price discount.
This time, it would be more prudent to follow Bill Tepper, Ray Dalio, Steven Cohen, Ken Griffin, Robe Citrone, D.E. Shaw and several other prominent investors who reduced their stakes in the company over the past few months, instead of emulating George Soros’ moves blindly.
Disclosure: Victor Selva holds no position in any stocks mentioned.