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John Kinsellagh
John Kinsellagh
Articles (115) 

Broadcom Jumps on the Cloud Computing Bandwagon

Company plans to leverage its newly acquired CA Technologies unit for entry and future growth into the burgeoning cloud services sector

December 10, 2018 | About:

Broadcom (NASDAQ:AVGO) posted strong fourth quarter earnings on Friday, surpassing Wall Street’s consensus forecasts. The company continues to generate enviable operating margins, and quarterly earnings were much stronger than anticipated. The icing on the cake for shareholders was the company’s announcement that it was hiking the dividend 50%. Broadcom also announced its $6 billion buyback plan, recently authorized by its board of directors.

The new quarterly dividend disbursement will be $2.65 per share, up from the previous $1.75. With the higher dividend, the stock’s current yield will be approximately4.5% — nearly double the average yield returned by companies in the S&P 500. Based on the company’s revenue guidance for next year, shareholders could see another dividend hike in the 20% range.

Group sales for the period rose 12%. Broadcom earned revenue of $5.45 billion, an increase of 12% from the same period last year, and earned $5.85 per share. Full-year revenue increased 18% to approximately $21 billion. Analysts’ expectations were for $5.4 billion and earnings per share of $5.58. Full-year revenues jumped 18% to just under $21 billion.

Broadcom provided guidance of $24.5 billion for its current fiscal year. This may be an overly optimistic projection in light of the company’s $18.9 billion deal to purchase CA Technologies, which closed in November.

The company’s operating margin for the current fiscal year is 50%. Even though Broadcom expects only a slight increase to 51%, due to the CA purchase in 2019, its operating margins are still ranked higher than 86% of the 849 companies in the semiconductor industry. Throughout its entire product range that includes signal filters and customizable ethernet switches, Broadcom converts 66 cents of each sale into gross profit compared to 38 cents for Apple (NASDAQ:AAPL), one of its largest customers.

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In light of declining iPhone sales, the company, an Apple supplier and chipmaker, is looking to supplement and expand its business into software and other cloud services areas. This is a prudent strategic shift, as revenue from the company’s wireless communication unit (31% of revenue) was unsurprisingly down 5% annually due to lower iPhone demand. Broadcom is placing a big bet on its ability to revamp and reorient CA’s traditional business strategy and revenue model in a more focused direction.

An integral part of Broadcom’s diversification efforts entails implementing a comprehensive overhaul of CA’s staid business model. CA has traditionally sold its software services as an end-user paid up royalty-free sale. Broadcom wants CA to move away from its model of constantly soliciting new business and instead focus its efforts on growing the revenue it receives from its existing customer base of 500 top corporations, which accounts for 70% of its revenue and includes some of the largest enterprises in the world.

One of the reasons for the initial tepid response by investors to the news of the CA acquisition was that there seemed to be little synergy between the core business operations of the two companies. CA has traditionally developed in-house software solutions for large corporations, while Broadcom’s emphasis has been providing signal switches and chips for phones and other hardware for networking and data warehousing services.

Broadcom is putting in motion a two-pronged strategy for its CA unit that will help it complement its traditional strengths as a chip manufacturer: Grow the software company’s existing business by offering its customer cloud computing services tailored to their specific IT needs and change the revenue stream by converting its services into a subscription model that will provide a predictable stream of recurring income.

Because of its long-term potential, many straight and cloud computing services companies are shifting to a subscription model. Microsoft (NASDAQ:MSFT)'s phenomenal growth over the past three years has been due to its aggressive push into the cloud services market where revenue sources are based on monthly service fees.

Broadcom plans to leverage CA’s valuable client base for cross-selling its chips and other necessary hardware for companies building new cloud systems. Indeed, Broadcom's 22% revenue increase over last year from its networking business, is due to strong demand for the burgeoning cloud services sector.

Broadcom’s stock is down 8% for the year but has rebounded more than 20% from its July low after the CA deal was announced.

Broadcom has a Petroski F Score of 8. GuruFocus has one severe warning sign for the company based on asset growth exceeding revenue growth and one good sign based on stable growth in revenue per share.

Disclosure: I have no position in any of the securities referenced in this article

About the author:

John Kinsellagh
John Kinsellagh is a freelance writer, former financial advisor and attorney specializing in civil litigation and securities law. He completed the Boston Security Analysts’ Society course on "Investment Analysis and Portfolio Management."
He has served as an arbitrator for FINRA for over 25 years resolving disputes within the financial services industry. He writes primarily on financial markets, legal and regulatory issues that impact the investment community and personal finance.
He is the author of "The Mainstream Media-Democratic Party-Complex" and "Election 2016", both available on Amazon. Follow him on Twitter @jkinsellagh

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