VMW - What To Expect From Broadcom In 2023

2023-10-24 04:38:03 ET

Summary

• Broadcom's revenue continues to grow year over year despite increased competition in the global semiconductor market.
• On the other hand, rising geopolitical tensions in the Middle East and the South China Sea are creating additional downward pressure on its share price.
• On May 26, 2022, Broadcom announced the acquisition of VMware in a deal valued at about $61 billion.
• However, the likelihood of this transaction being completed before October 30 is not high, given the news published by Reuters.
• We initiate our coverage of Broadcom with a "hold" rating for the next 12 months.

Broadcom ( AVGO ) is one of the largest technology companies in the world, headquartered in San Jose.

Broadcom products are essential components of various devices. As a result, revenue in the semiconductor solutions segment continues to grow yearly despite increased competition in the global market. On the other hand, despite the remarkable growth rate of demand for its generative AI products, rising geopolitical tensions in the Middle East and South China Sea are creating additional downward pressure on its share price. The reason for this is growing concern among financial market participants about the possible joining of other countries in the war between Israel and Hamas, which will lead to a slowdown in the global economy and a decrease in demand for the company's chips.

On the other side, over the past few years, Broadcom has pursued an aggressive M&A policy to expand its business, diversify its product portfolio to be more resilient in the event of negative changes in the global semiconductor market, and gain access to technologies and patents.

Four years after the company withdrew its $117 billion bid to acquire Qualcomm after Trump blocked the deal, Broadcom has set its sights on acquiring a leading provider of virtualization and cloud computing software and services.

So, on May 26, 2022 , Broadcom announced the acquisition of VMware in a deal valued at about $61 billion. However, as with the attempt to acquire Qualcomm, something goes wrong. After the European Union, Canada, South Korea, Brazil, and many other countries, including the UK, permitted Qualcomm to purchase VMware, we assessed that it was highly likely that the deal would be closed on time.

However, rising geopolitical tensions between China and the United States, including due to the Biden administration's ban on the export of American chips to Beijing, threaten the closure of the acquisition of virtualization giant VMware on October 30. In addition, it should be noted that earlier, Chinese regulators began to pursue a stricter policy regarding large M&A transactions, including not allowing Intel ( INTC ) to acquire Tower Semiconductor ( TSEM ) for $5.4 billion .

We believe that Beijing will not block Broadcom's acquisition of VMware, given the legal merger clearance already received from many other countries and the blocking of Intel's purchase of Tower Semiconductor. Because otherwise, this will raise many questions about the objectivity and independence of China's regulatory authorities from the influence of its Communist Party and thus may contribute to a decrease in its investment attractiveness. However, the likelihood of this transaction being completed before October 30 is not high, given the news published by Reuters , which is also reflected in the price of VMware shares, which have decreased by 15% over the past week.

In addition, the five largest shareholders of Broadcom, with a total stake in the company equal to 34.44%, have long been such Wall Street titans as Capital International Investors, Vanguard Group, BlackRock, Capital World Investors, and Capital Research Global Investors.

Moreover, since the beginning of 2023, there has been a significant increase in the share of institutional investors in the total number of shares outstanding. This growth is one of the factors indicating their confidence in Broadcom's bright future despite increased competition in the global semiconductor market and doubts regarding the closure of the VMware acquisition.

At the same time, the third quarter of the fiscal year 2023 showed tremendous results since not only Broadcom's revenue was able to exceed analysts' expectations, but more importantly, the trend of growth in its EPS on a quarterly basis has continued in recent years. Moreover, demand for the company's products and services continues to remain extremely high, indicating the management's adeptness in efficiently handling the company, even in the face of central banks raising interest rates, which, among other factors, slow down global economic growth.

Broadcom is expected to release its financial report for the fourth quarter of fiscal year 2023 on December 8, 2023. According to Seeking Alpha , the company's fourth-quarter fiscal 2023 revenue is expected to be $9.24 billion to $9.31 billion, up 4.3% year-over-year and 4.7% higher than analysts' expectations for the prior quarter. At the same time, according to our model, Broadcom's total revenue will be within this range and amount to $9.31 billion.

At the same time, we predict that Broadcom's operating income margin will reach 44.5% by fiscal year 2023. On the other hand, by the fiscal year 2024, this financial metric will decrease to 37.3%, mainly due to the completion of the acquisition of VMware. So, VMware's operating income margin was 17.14% in the second quarter of fiscal year 2024, a slight decrease compared to the previous year.

According to Seeking Alpha , Broadcom's fourth-quarter fiscal 2023 EPS is expected to be $10.71-$11.08, up 5% from the consensus estimate for the third quarter of fiscal 2023. On the other hand, according to our model, Broadcom's EPS will amount to $11, an increase of 7% compared to the previous year.

At the same time, Broadcom's Non-GAAP P/E [TTM] is 21.21x, which is 17.58% higher than the sector average and 28.04% higher than the average over the past five years. On the other hand, the Non-GAAP P/E [FWD] is 20.97x, which is also higher than its main competitors, such as Texas Instruments and Qualcomm.

In addition to the continued strong demand for Broadcom's networking products, another contributing to its beating consensus EPS is its share repurchase program. Since the fourth quarter of fiscal year 2022, the amount of cash flow allocated to this purpose remains exceptionally high. For the three months ending July 30, 2023, Broadcom repurchased its shares for about $2,167 million of its shares, an increase of 20.9% compared to the previous year.

At the same time, at the end of the third quarter of fiscal year 2023, the remaining authorization to buy back Broadcom shares was about $7.3 billion . This remaining amount could mitigate the negative impact caused by short sellers on Broadcom's share price, especially if sales of the iPhone 15, which uses the company's chips, fall below analysts' expectations.

Conclusion

Broadcom is one of the largest technology companies in the world, headquartered in San Jose.

The increase in sales of the semiconductor solutions segment and the continued high demand for Broadcom's services are contributing to the growth of interest in it from institutional and retail investors. As a result, the company's share price has risen more than 54% since the beginning of 2023, outperforming Taiwan Semiconductor ( TSM ) and Intel, its key competitors in the technology sector.

On May 26, 2022, Broadcom announced the acquisition of VMware in a deal valued at about $61 billion. Rising tensions between the US and China in recent quarters also have a negative impact on this deal. As a result, an increasing number of financial market participants are skeptical about closing the deal before October 30, reflected in the price of VMware shares, which have decreased by 15% over the past week. As a consequence, this is the first risk we highlight. Without the completion of this deal, the company's annual revenue growth rate will be below our expectations.

The second key risk to Broadcom's financial position is the continued rise in US household debt, which, among other things, slows the growth rate of consumer spending, which could ultimately lead to a decrease in demand for electronic devices that use the company's chips.

Even though Broadcom has a policy of increasing its dividend payout year over year and reducing its total debt/EBITDA ratio year over year, we believe that, given technical analysis, Broadcom's share price continues to move downward and has recently bounced off the resistance line, which formed way back in early October 2023. We expect a continuation of the corrective movement within the A-B-C pattern up to a strong support zone in the range of $830 to $831 per share.

We initiate our coverage of Broadcom with a "hold" rating for the next 12 months.

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