It may not be completely Nvidiabut the leading chip designer and infrastructure software provider Broadcom (NASDAQ: AVGO) has been on an epic run of its own. Shares of Broadcom are up just over 60% so far in 2024 – just shy of Nvidia’s more than 170% rise. What a year when being “only” 60% doesn’t set any records!
Along with its latest earnings update, Broadcom also announced a 10-for-1 stock split that will take place in July 2024. Share price aside (a split doesn’t change the underlying value of the stock), Broadcom has created a business unique that it may have a lot more to give to its shareholders over the next few years. Here’s why it may not be too late to buy, but also reasons to be carefully optimistic.
Built by acquisition, unlike any other chip company
Broadcom, under the leadership of CEO Hock Tan, has become a giant through many acquisitions. As Avago (headquartered in Singapore), Tan orchestrated the acquisition of Broadcom in 2016 (Avago then took the name of the acquirer), and a few years later re-domiciled the corporate headquarters in the US
After a long series of chip design acquisitions, notably starting in 2017, Tan and company turned its attention to acquiring enterprise software businesses. This culminated in the acquisition of top cloud management software provider VMware in 2023.
The key point here is that Broadcom’s exceptional leadership in acquiring many chip technologies and managing them extremely well (especially in terms of profitability) has put Broadcom in a key position to benefit from the artificial intelligence (AI) infrastructure boom ). Of course, Nvidia has pioneered and dominated the brand new AI training data center market. But as operators of large data centers begin to face the challenge of using that AI on a daily basis in their existing data centers, many have turned to Broadcom’s efficient chip design know-how and enterprise software.
In its most recent quarter (fiscal Q2 2024, the three-month period ended May 5), Broadcom reported 6% year-over-year growth in semiconductor sales. That may not sound like much, but most of the semiconductor industry, excluding artificial intelligence (AI) infrastructure, remains in deep decline. Broadcom’s growth during this period means it is taking a lot of market share. Tan said sales of AI-specific chips rose 280% year-on-year last quarter.
A mega-purchase with many question marks
In addition to all the AI chip stuff, VMware is also dabbling in Broadcom’s software segment — which now accounts for about 40% of total revenue. VMware was a critical cloud software provider that enabled the sharing and sharing of data center computing power to companies that wanted to “rent” computing power, but it was a poor software investment. Tan and the company are trying to change that quickly, primarily by changing its VMware partner program (consultants and such who resell VMware products to existing customers).
As it has done with previous software acquisitions, Broadcom is focusing on its largest, most profitable VMware relationship. Tan said on the recent earnings call that the old partner program threw VMware into “chaos,” so fixing the problems (read: making VMware dramatically more profitable) is just as messy an endeavor.
The good news is that VMware is indeed starting to become more profitable, even if actual VMware-specific revenue growth beyond this year may not be much of a factor. However, Broadcom’s total adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) was 61% last quarter. Once integration spending is largely completed next year, VMware could help Broadcom’s free cash flow margins reach close to 50% of what they were last year (an incredible 49% free cash flow margin was the total for 2023, versus 36% this past quarter).
Even after its incredible growth, Broadcom trades for a reasonable-looking free cash flow of 44 times trailing-12-months. It’s a price premium, but one that could be mitigated significantly if the company continues to drive growth in AI semiconductors and unlock cash from its large software segment.
Another reason to check runaway optimism is the huge debt load Broadcom took on to buy VMware. Total debt now stands at $74 billion, although management says it plans to continue paying that down at a rate of roughly $2 billion per quarter.
I’m a happy shareholder and believe the good times will continue to roll for Broadcom this year. Watch progress with VMware and related debt burden as 2024 progresses.
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Nicholas Rossolillo and his clients have positions in Broadcom and Nvidia. The Motley Fool has positions on and recommends Nvidia. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
So far this year 55%, is it too late to buy Broadcom shares? was originally published by The Motley Fool