Broadcom - Valuation

Friday, February 29, 2008

The last article in my Broadcom's article on Sramana Mitra's site..

The last month has been a great revelation for me. I have ventured beyond my comfort zone to research and understand the nuances of various other related segments like WLAN, Bluetooth, GPS, set-top boxes, broadband modems, DVD players, and Ethernet. Such is the depth of Broadcom’s business. Before I go into the details of this valuation, I wish to emphasize that I have learnt as much as you have through this process and have tried my best to present an objective, unbiased, well-researched and detailed work. I hope that this analysis provides a comprehensive data-point for your investment decisions.

I value Broadcom at $39.30 per share. Surprising, considering that the company’s share price is hovering under $20 these days. However, it should also be noted that this is only a few dollars off the company’s 52-week high of $43.07. This valuation is buttressed by the strength of the Mobile and Wireless business and complemented by the stability offered by the other businesses.

I would also like to put it in context. There is a reason why the shares are viewed unfavorably now. Apart from the lack of sizeable 3G design wins, it is the company’s expense management that has been causing worries in the market. The company spent over a quarter of its revenues in R&D, primarily associated with the conversion to 65 nm. Secondly, its protracted legal battle with Qualcomm has increased its SG&A expenses in recent times. These two factors have kept the operating margins low. The result is the depletion of its profits to a very small percentage of its revenues. It is illustrative (though unrealistic) to see what happens if Broadcom continues to incur high expenses. An additional operational overhead of 45% subtracted from its revenues yields a valuation of $22.24. Add to this a degree of uncertainty surrounding the mobile business and voila, you get closer to the current share prices.

The expenses last year have been a necessary evil to complement Broadcom’s aggressive mobile phone campaign. But the company’s management has taken pains to assure investors that its expense management is back on track. Additionally, they assert that once the mobile design wins start to yield revenues, the R&D expenses will be per the model of 20-22%. Broadcom also demonstrated slightly reduced Operating expenses in Q4 2007 as a pointer towards their internal measures to tighten the screws. In order for the company to successfully execute these promises, it needs more design wins and I am sure its Product marketing department is working round the clock to achieve this.

In summary, the $39.30 valuation is contingent on Broadcom’s mobile success and careful expense management. While this valuation relies substantially on the market condition and Broadcom’s proven product delivery track record, the reality depends on its continued ability to come up with competitive products and secure actual design wins. So, while my valuation is twice the current share price, I suggest waiting for another quarter or two before making an investment in the company. At the same time, my thought for those who currently own the company’s shares is to hold on to it. I don’t expect the share price to drop much below its current value. In either case, you will have more data this year to make your moves.

Disclaimer: These are my perspectives on Broadcom and does not necessarily reflect the views of Atheros Communications or Tensorcomm.

Posted by Vijay Nagarajan at 9:00 AM  


Vijay how did you get to $39.30, can you detail your analysis? Thank you.

Carlos said...
March 30, 2008 at 6:37 AM  

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