It may not be entirely true Nvidiabut top chip designer and supplier of infrastructure software Broadcom (NASDAQ:AVGO) has been on an epic run under its own steam. Broadcom shares are up just over 60% so far in 2024 – slightly more than Nvidia’s rise of over 170%. What a year in which an increase of “only” 60% does not produce a single record!
Along with the latest earnings update, Broadcom also announced a 10-for-1 stock split that will take place in July 2024. Stock price aside (a split doesn’t change the fundamental value of shares), Broadcom has created a unique company that may have a lot more to offer its shareholders in the years to come. Here’s why it may not be too late to buy, but also reasons it should be carefully optimistic.
Built by acquisition, unlike any other chip company
Under the leadership of CEO Hock Tan, Broadcom has developed into a giant through many acquisitions. As the company Avago (headquartered in Singapore), Tan orchestrated the purchase of Broadcom in 2016 (Avago subsequently adopted the name of the acquired company), and a few years later moved its headquarters to the US.
After a long string of chip design acquisitions, mostly starting in 2017, Tan and his company turned their attention to acquiring enterprise software companies. This culminated in the purchase of top cloud management software vendor VMware in 2023.
The takeaway here is that Broadcom’s exceptional success in acquiring many chip technologies and managing them exceptionally well (especially in terms of profitability) has put Broadcom in a crucial position to benefit from the artificial intelligence (AI) infrastructure boom. Nvidia has obviously pioneered and dominated the brand new AI training data center market. But now operators of large data centers are starting to grapple with the challenge using As they use AI every day in their existing data centers, many of them have turned to Broadcom’s efficient chip design know-how and enterprise software.
In its most recent quarter (Q2 fiscal 2024, the three-month period ended May 5), Broadcom reported 6% year-over-year growth in semiconductor revenue. That may not sound like much, but much of the semiconductor industry, with the exception of artificial intelligence (AI) infrastructure, is still in a deep recession. Broadcom’s growth during this period therefore implies that it is gaining a large market share. Tan said sales of AI-specific chips rose 280% year-on-year last quarter.
A mega acquisition with many question marks
In addition to all the fuss about AI chips, VMware is also being included in Broadcom’s software segment, which now makes up about 40% of total revenue. VMware was a crucial cloud software provider that made it possible to split and distribute data center computing power to companies that wanted to “rent” computing power, but it was a lackluster software investment. Tan and company are trying to change that quickly, mainly by tinkering with their VMware affiliate program (consultants and the like who resell VMware products to real end customers).
As with previous software purchases, Broadcom is focusing on the largest, most profitable VMware relationships. Tan said during the last earnings call that the old partner program left VMware in “chaos,” so fixing the problems (read: making VMware dramatically more profitable) is an equally messy endeavor.
The good news is that VMware is indeed starting to become more profitable, even if actual VMware-specific revenue growth may not play much of a role after this year. Still, Broadcom’s total adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) last quarter was 61%. Once integration costs are largely complete next year, VMware could help Broadcom’s free cash flow margins get close to 50%, as they did last year (an incredible 49% free cash flow margin was the total for 2023, up from 36% the latter quarter).
Even after the incredible rise, Broadcom trades for a reasonable-looking free cash flow of 44 times the trailing twelve months. It’s a premium price tag, but one that could moderate significantly if the company continues to increase AI semiconductor growth and unlock money from its large software segment.
Another reason to curb the runaway optimism is the large debt burden that Broadcom took on to acquire VMware. Total debt now stands at $74 billion, although management says it plans to continue paying it down at a pace of about $2 billion per quarter.
I am a happy shareholder and believe the good times will continue for Broadcom this year. Keep an eye on VMware’s progress and related debt load as 2024 progresses.
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Nicholas Rossolillo and his clients have positions in Broadcom and Nvidia. The Motley Fool has positions in and recommends Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
Up 55% so far this year. Is it too late to buy Broadcom stock? was originally published by The Motley Fool
