Broadcom Inc. (AVGO, Financial) is a leading semiconductor and infrastructure software solutions provider, catering to diverse markets such as storage, fiber channel, networking and broadband. With a highly specialized product portfolio and technology leadership, the company is well-positioned to edge out competitors. In addition, its focus on the artificial intelligence (AI) market drives its "compute offload accelerated" business growth. This article will delve into current factors that I believe make Broadcom an appealing long-term growth play.
Rapid response to AI
The race to dominate the AI market is heating up, with tech giants like Broadcom and Nvidia (NVDA, Financial) capitalizing on the trend. In its latest earnings report, Broadcom, traditionally known for its radio-frequency components used in Apple's (AAPL, Financial) iPhones, revealed a surge in sales due to customers eager to strengthen their networks for generative AI. The demand for this technology, popularized by ChatGPT, is boosting what Broadcom calls its compute offload accelerated business. As a result, the company expects to generate $3 billion in revenue this fiscal year, up from $2 billion last year.
Despite the economic downturn affecting consumer and enterprise spending, AI is a bright spot for chip companies like Broadcom. Broadcom expects "exponential" demand for its networking solutions this year from hyper-scale customers eager to deploy AI in their systems. This demand is expected to drive a 20% growth in networking revenue for the current quarter alone.
Notably, the AI boom can be considered a green zone for the chip industry, which has faced challenges in other areas like broadband and cloud spending. In the AI space, as an under-appreciated mover with a valuation far cheaper than other chip makers like Nvidia and Advanced Micro Devices (AMD, Financial), I believe Broadcom has more upside to go.
Additionally, Broadcom is making strides to further entrench itself in the AI market through cloud computing sales for generative AI projects. Its AIOps service is already helping IT teams detect and remedy technical issues for clients, giving the company a foothold in the market. The company has disclosed that it expects AI-related, high-speed cloud switch sales to bring in $800 million, a 300% increase from its current earnings. By positioning itself as an appealing "pick and shovel" play, Broadcom is attracting AI-frenzied investors who see the company as a critical player in the growth of generative AI products in 2023 and beyond.
Overall, I think the AI arms race will continue to drive growth for chip stocks like Broadcom as the demand for AI chips grows. As companies like Alphabet (GOOG, Financial)(GOOGL, Financial) and Microsoft (MSFT, Financial) continue integrating generative AI into their search engines, the competition will only intensify, making it an excellent time to have some chips in the AI game.
Custom silicon accelerators
Broadcom boasts a scale of 120 silicon tape outs per year across all nodes and product lines, driven by its research and development platform scale. In addition, its investment scale enables it to develop a new technology platform every two years. The research and development scale, combined with an efficient design methodology, allows the company to develop around 60 ASICs at any given time, with designs in future generations expected to double the current complexity.
Its packaging technology leadership has led to the evolution of 2D packages into 2.5D and 3D packages with the introduction of the industry's first 5-nanometer optical digital signal processor (DSP) with integrated trans-impedance amplifier and laser driver.
Broadcom has also expanded into new growth markets, including custom silicon and hyper-scale accelerators, with domain-specific architectures outperforming GPUs with higher performance based on over 20% lower area and power. In addition, its AI application-specific integrated circuits in production have increased from three in 2018 to nine in 2022.
Broadcom has also focused on 5G radio with a System On Chip (SoC) opportunity of $1.2 billion (in terms of serviceable available market (SAM)) in 2024. Finally, Broadcom has opportunities in data center interconnect, with integrated PAM-4 DSP, and the transport and routing network, with coherent DSP, with estimated SAM opportunities of $800 million and $400 million in 2024, respectively.
As a result, Broadcom is well-positioned for the future due to its technology leadership in semiconductor and infrastructure software solutions, an extensive portfolio of innovative products and a robust financial model driving diversified and sustainable revenue, supporting a 38% per year dividend growth rate from the fiscal years 2016 through 2023.
Source: Broadcom investor relations
Storage and fiber channel
Broadcom holds category-leading franchises in the storage and fiber channel markets, catering to diverse end markets. Its enterprise-grade storage solutions offer drive protocol conversion, drive failure protection and server power failure protection. Broadcom's data protection usage is widespread across various sectors and applications, with 10 of the top 10 server original equipment manufacturers utilizing its technology. It is a crucial player in the changing profile of hard disk drive data storage, enabling $10 billion annually in the growing nearline hard disk drive market. This market is supported by Broadcom's leadership and is expected to see a 20% growth in revenue over the long term.
Networking and broadband
Broadcom is a leading networking and broadband solutions provider, with its chips handling 99.9% of all internet traffic. Its expertise and partnerships drive innovation and have a long history of being the first to market with new technology. The company consistently innovates, producing a high-performing and feature-rich product portfolio that meets customer needs at different price points. Its ability to integrate systems and software also sets it apart.
The Tomahawk 4 chip delivers a six-fold performance improvement at 25.6 terabits per second and a 75%+ system power and cost reduction. In addition, Broadcom operates at scale, producing six to eight new chips per year. Its latest product, the Tomahawk 5 family of Ethernet switch/router chips, is the world's first 51.2 terabits per second switch in production volume, available for production deployments in only seven months from initial samples.
Broadcom also offers silicon photonics platform solutions with disruptive system value, delivering a 30% power consumption savings, a 40% lower optics cost per bit and a 50% improvement in rack density and integration time. In addition, with the scale-up/out interconnects of the Janssen Silicon Photonics platform, Broadcom expands its SAM by over $3 billion.
Its innovative solutions are in high demand, with a $100 billion annual Capex (at 15% CAGR) spent by the total cloud market and 19.5 zettabytes of cloud data movement. As a result, it is positioned to continue leading the industry with its disruptive technologies and ability to meet the evolving needs of its customers.
Potential VMware synergies
Broadcom has set its sights on acquiring cloud computing company VMware (VMW, Financial) for a whopping $61 billion in cash and stock. This acquisition marks a significant step forward in Broadcom's strategy to become the world's leading infrastructure technology company, with a proven track record of acquiring established, mission-critical platforms.
Furthermore, as the category leader in private cloud infrastructure with a complementary product portfolio, VMware holds a leadership position in a large and foundational market, making it a financially compelling opportunity for Broadcom. VMware also serves as the foundation for the mission-critical applications of today's global enterprises across private and public clouds, further strengthening Broadcom's position in the market.
Source: Broadcom investor relations
However, the acquisition has been challenging. An investigation has been initiated by the European Commission over the deal, citing concerns over potential anti-competitive effects in the market for specific hardware components that interoperate with VMware's software. While the deal has received approval in Brazil, South Africa and Canada, the UK competition watchdog is still investigating the acquisition.
Despite the regulatory hurdles, Broadcom remains optimistic about the acquisition. Once the deal is closed, the Broadcom Software Group will rebrand and operate as VMware, incorporating Broadcom's existing infrastructure and security software solutions as part of an expanded VMware portfolio.
In conclusion, the acquisition of VMware by Broadcom presents several potentials for the company, including expanding its platform of critical infrastructure solutions and strengthening its position in the market. While regulatory challenges persist, Broadcom remains committed to closing the deal in its fiscal year 2023.
The cooling effect of Apple's chip strategy
Apple is set to replace a key Broadcom chip with its own design by 2025. This move is part of Apple's strategy to limit its reliance on other chip makers and focus more on its line of chips. The chip in question is Broadcom's Wi-Fi and Bluetooth chip, and Apple is already developing an in-house replacement. Additionally, Apple plans to swap out Qualcomm's cellular modem chips with its own by the end of 2024 or early 2025.
Broadcom is set to take a hit from this decision, as the tech giant is its largest customer and accounted for about 20% of its revenue last fiscal year. As a result, this move could negatively impact Broadcom's revenue by $1 billion to $1.5 billion. For Apple, pivoting to in-house manufacturing presents many risks, including high costs and starting from scratch.
Overall, Broadcom remains confident as its technology is the best in the market, and there's no reason for Apple to look elsewhere. However, Apple's move will create a headwind for investor sentiment, given how significant Apple's revenue contribution is to Broadcom.
Takeaway
In conclusion, Broadcom is set to benefit from the growing demand for AI technology as sales surge due to customers seeking to strengthen their networks for generative AI. Although the acquisition of VMware has faced some challenges, Broadcom's strategic vision and proven track record position it as a leader in the infrastructure technology industry. Apple's decision to replace Broadcom chips presents risks. However, Broadcom's extensive portfolio of innovative products, technological leadership and financial stability make it well-positioned to harness value potential over the long term.
