Despite a rough 2012 for the entire semiconductor industry, Broadcom Corporation (NASDAQ:BRCM) reported 8% growth in annual revenue. Additionally, it reported an increase in market share for all of its business units; however, net income exhibited a sharp drop predominantly due to an increase in operating costs.
I believe Broadcom Corporation (NASDAQ:BRCM) has robust fundamentals, and the company’s stock has a higher-intrinsic value than its current trading price. With strong potential upside in its stock, investing in Broadcom provides a reasonable margin of safety for investors. Below is my rationale that underpins a higher stock valuation.
Business segments
As an investor, it’s absolutely mandatory to understand a company’s revenue streams in order to make the right investment choice. Broadcom‘s wireless connectivity and baseband apps contribute the highest percentage to total revenue, at around 50%. This is followed by home entertainment broadband and licensing, which contributes around 29%, and infrastructure networking at 23%.
Broadcom Corporation (NASDAQ:BRCM) is extremely dominant in the wireless connectivity market, with a market share of 36%. In the mobile baseband and processors market, however, it holds only a 4% market share.
Market leader in wireless connectivity solutions
Broadcom Corporation (NASDAQ:BRCM) is a leader in the mobile-wireless market by a significant margin. During 2012, its wireless-connectivity business reported a faster growth rate relative to the overall business.
Broadcom’s wireless-connectivity division, which is primarily comprised of smartphones and tablets, contributes approximately 50% to overall revenue. It must be said that smartphones and tablets are the most promising division within the semiconductor industry, and therefore present massive growth potential in the long run.
It’s worth noting that Broadcom has exhibited its competence in broadening its 5G WiFi chips from routers to various other smart devices. Further, Broadcom plans to target both high-end and mass-market mobile phones by adding NFC Quad-core chips to its product offerings.
Broadcom has enjoyed tremendous success within the wireless connectivity market, especially for mobile devices. Going forward, I expect the trend to continue.
Position in baseband and application processor market can improve
In the baseband and application processor market, Broadcom Corporation (NASDAQ:BRCM) has not enjoyed similar success to what it has experienced in the connectivity-solutions market. As previously noted, the current market share stands at a mere 4%.
Nevertheless, Broadcom has made considerable efforts to improve its mobile product portfolio. It has incrementally developed its 40-nm platform to bolster the 3G business. It recently launched a new 3G platform that manages data at faster speeds and includes the new high-speed packet-access processors for low-end or mid-market smartphones
Broadcom faces a stiff challenge from QUALCOMM, Inc. (NASDAQ:QCOM) in the baseband and application-processor market. Qualcomm is the leader in this segment; however, with Broadcom’s tremendous success in mass-market Android-based mobile phones, I expect Broadcom to grow its market share in this segment and narrow the gap.
Enterprise spending to increase
Due to a decline in enterprise spending, Broadcom Corporation (NASDAQ:BRCM) marked a weak performance in its infrastructure and networking business division. In the near term, demand is still expected to remain low, as the macroeconomic conditions coupled with seasonal variations will cause a slowdown. Nonetheless, Broadcom’s efforts to bolster its infrastructure and networking business division should spur growth in the long run.
During 2012, Broadcom introduced its first 28-nm multi-core network chip. Additionally, to strengthen its position in the enterprise market, it also introduced the revolutionary Ethernet switches. The Ethernet switches, which are predominantly for the enterprise market, are accustomed to dealing with any escalation in workforce mobility.
Backed up with NetLogic’s multi-core processor solution, I expect Broadcom to increase the size of its potential target market in infrastructure and networking and generate higher revenue in the future.
Competitive threats that may hinder growth
Within the wireless connectivity market, Broadcom Corporation (NASDAQ:BRCM) faces stiff competition from Texas Instruments Incorporated (NASDAQ:TXN).
Texas Instruments generates the highest percentage of its revenue through analog semiconductors at around 55%. This is followed by DLP products, calculators and royalties and embedded processors at around 19% and 15%, respectively. It also adds a small percentage to its overall revenue through application processors and connectivity at 11%.
Texas Instrument has been fairly dominant in the wireless-semiconductor market. At present, itsmarket share in cellular baseband, connectivity solutions and application processors stands at 13%, 12% and 11%, respectively.
Texas Instruments Incorporated (NASDAQ:TXN) ceased all of its baseband operations at the end of 2012 in an effort to increase its OMAP footprint. This has led to a sharp decline in the company’s market share in wireless semiconductors, as cellular baseband generated approximately 60% of total wireless revenue.
The analog semiconductors, which represents the highest-contributing revenue stream for Texas Instruments, possessed a market share of 16% at the end of 2012. Further, gross margin for the same hovered around 52% during the last fiscal year.
Going forward, I believe the industry dynamics are expected to change, with several companies willing to outsource manufacturing in order to reduce the fixed cost and overall CAPEX.
Texas Instrument owns most of its production facilities, which implies a high level of operating leverage–thus any reduction in demand can negatively affect the company’s profit. Moving ahead, this may put pressure on Texas Instruments Incorporated (NASDAQ:TXN), as competitors that outsource manufacturing have a higher level of flexibility in product pricing and therefore can address the falling demand accordingly, unlike Texas Instruments Incorporated (NASDAQ:TXN).
As previously mentioned, Broadcom also competes with QUALCOMM, Inc. (NASDAQ:QCOM). Qualcomm generates the highest percentage of its revenue through mobile-device chipsets, at around 64%. This is followed by mobile-device royalties at around 30%. According to the projections offered by Trefis, Qualcomm’s free cash flow for the year 2013 is expected at around 43% of its total gross profit.
During 2012, QUALCOMM, Inc. (NASDAQ:QCOM)’s market share in the chipsets category stood at 65% It plans to bolster its 3G business by expanding in India and China. However, it now faces an increasing threat from Broadcom’s growing presence in this category.
Stock price has 15%-to-25% upside potential
Broadcom Corporation (NASDAQ:BRCM) is gaining huge momentum in the set- top box business, as it reported a 15% increase in shipments during fiscal 2012.
The outlook is highly favorable, as demand for technologically advanced set-top boxes from developed countries is only expected to grow. Further, the shift to digital platforms in emerging markets should also add to the overall growth.
As per my estimate, the wireless and connectivity division, which is the most valued business category for Broadcom, is expected to report consistent growth for the next five years. According the valuation offered by Trefis, the free cash flow generated through this division will stand at around $600 million during 2013.
Using the DCF model, my conservative target price for Broadcom’s stock should be around $38.15 (15% upside); however, a more bullish view on its stock gives us a target price of $41.43 (25%). This bullish view implies more-than-expected growth in all business categories.
Ashit Gulati has no position in any stocks mentioned. The Motley Fool owns shares of QUALCOMM, Inc. (NASDAQ:QCOM).
