On its recent earnings call, tech giant said Broadcom (NASDAQ:AVGO) announced it would split its shares 10-for-1 on July 12. Considering that Broadcom’s stock rose more than 12% to $1,700 per share the day after the report, you might say a stock split was overdue.
Note that Broadcom’s stock split will not change the value of the company itself, which is currently around $780 billion. While stock splits may make it easier for retail investors and employees to purchase shares (such as with employee stock purchase plans), splits do not change a company’s fundamentals, such as earnings, revenue growth, or intrinsic value.
As such, a stock split is never a reason to buy a stock. However, Broadcom also provided compelling reasons for the post-earnings surge and continued ownership, especially in its two key product segments.
VMware looks like a home run
Although Broadcom has historically been primarily a semiconductor company, the software segment now accounts for more than 40% of revenue, which equates to 42% of last quarter’s revenue. That’s thanks to the $69 billion acquisition of VMware, which closed in the fourth quarter of last year.
VMware is already looking like a home run for Broadcom. Not only has Broadcom been able to extract a significant amount of cost from VMware (which is typical when a large company acquires another company), but it has also been able to accelerate VMware’s revenue growth again.
In the second fiscal quarter of 2024, VMware’s revenues were $2.7 billion, compared to just $2.1 billion in the previous quarter. That’s an incredible 29% acceleration in just one quarter, for an astonishing 173% growth rate!
Broadcom has been able to accelerate VMware’s transition to a recurring subscription model, rather than one-time license purchases, a transition that was already underway before the acquisition. But perhaps even more important is the recent introduction of vSphere, a new platform that allows companies to virtualize all parts of their on-premises data centers, making it as easy and intuitive for employees to use a company’s data center as public clouds. This is unlike previous offerings that virtualized only one aspect of a company’s data centers, such as computing, networking or orchestration.
Whether or not this is due to Broadcom’s influence or VMware’s R&D efforts leading up to the acquisition, Broadcom is now reaping the benefits.
During the conference call with analysts, Broadcom CEO Hock Tan said he expects VMware’s revenue to reach $4 billion quarterly in the near term. Not only that, but Tan sees Broadcom ultimately being able to cut a huge amount of overhead costs, helping to reduce VMware’s quarterly operating costs from $2.3 billion before the acquisition to $1.6 billion last year. quarter, on track to eventually reach $1.2 billion.
In VMware’s last standalone quarter, which ended in July 2023, it achieved a gross margin of 81.2%. So assuming the segment achieves Tan’s revenue of $16 billion, and Broadcom can maintain VMware’s historic gross margins while reducing quarterly operating expenses to $1.2 billion, VMware’s operating profit should theoretically improve to $8.2 billion – an incredible profit figure on a $69 billion purchase. after just a year or two, especially for a ‘sticky’ enterprise software platform that tends to command high multiples in the public markets.
And Broadcom’s AI products are firing on all cylinders
Beyond VMware, Broadcom’s AI product portfolio continues to shine. As a reminder, Broadcom has two broad categories of AI products: networking products, such as Ethernet-based switching chips and digital signal processors, and custom ASIC (application-specific integrated chip) IP, which cloud companies use to build their own custom AI accelerators. For custom ASICs, Broadcom counts Alphabet And Metaplatforms as customers, with a third said to be Tik Tok parent Bytedance.
Broadcom’s overall “networking” category, which includes these two product lines, rose 44% last quarter and now represents just over half of the company’s semiconductor revenue, at 53%.
Tan particularly highlighted the strong growth in switching chips, PCIe switches and network controllers, all of which doubled from the previous year, as networking and memory have effectively become the key bottlenecks for AI computing.
Moreover, the strong results may have allayed concerns about this Nvidia‘S (NASDAQ: NVDA) The Infiniband technology could take market share from Ethernet, where Broadcom dominates. In fact, Tan noted that seven of the eight largest AI clusters ran on Ethernet technology last year, and all eight will run on Ethernet technology in the coming year. And while Nvidia is also coming to market with its own new Ethernet products, Broadcom is the established leader and is clearly seeing very strong momentum right now.
Broadcom remains a core technology holding company
Broadcom isn’t as cheap as it was before AI came along, at about 40 times annual run-rate revenue last quarter. However, AI growth remains extremely strong, while the company has not yet even seen the full financial benefits of its VMware integration kick in.
Meanwhile, Broadcom’s other segments outside of AI and software have shown low or even negative growth, with mobile chips growing just 2% last quarter, storage connectivity hardware down 27%, and broadband revenues down as much as 39%. However, Tan said the company sees these non-AI segments hitting a trough and then starting to recover in the second half of the year.
So with VMware’s earnings rising, AI revenues exploding, and non-AI revenues recovering from a downturn, expect Broadcom’s earnings to rise in the second half of the year and beyond, likely driving the stock will become much cheaper based on future profits.
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Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, former director of market development and spokeswoman for Facebook and sister of Mark Zuckerberg, CEO of Meta Platforms, is a member of The Motley Fool’s board of directors. Billy Duberstein and/or his clients have positions in Alphabet, Broadcom and Meta Platforms. The Motley Fool holds positions in and recommends Alphabet, Meta Platforms, and Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
Broadcom’s stock split isn’t a reason to buy stock: These two reasons were originally published by The Motley Fool
